No 1031 then what?

[monnchew]

It sounds like a 1031 is really only beneficial for rental properties, not for any other use.  Is that correct?

What I'm trying to do is defer most of my taxes from rehabing properties and investing into more rehab homes without being hit by short term capital gains.  And eventually, when I have enough equity in these properties, get into the rental side.  Is there any way to do this?

Also, what is my tax situation going to look like with a this scenario:

Bought 1st rehab for $40K.  Added $13K for repairs.  And after realtor fees and other costs made about $20k in profit.

I then mortgaged another rehab, but took the $20k and used it for repairs. Will this be a wash or will I have some large tax consequences?

[henryinma]

I don't know of any other way to defer short term capital gains.

As for what will likely happen. You'll owe taxes on your 20k of profit. This will be taxed at the short term capital gains rate which if you're in the 28% tax bracket, will be 28%. You will also owe state taxes on the gain, so depending on your state, add in another 0-8%. Also as it was a flip, it's considered income and you'll have to pay self employment taxes (social security) which is about another 15%. So on that 20k of profit, about 43-51% of it could be gone through taxes.

Now you'll have to come up with that 9-10k for taxes. What you did with the 20k doesn't really matter. If you sell the other property, maybe you can get the money out of it to pay your taxes otherwise I hope you have that money in some account to pay the taxes.

Flips look good on TV, but you lose way too much on taxes. Also it's a job, once you stop doing it, the income from it stops as well.

[dwj469]

Great post Henry, I completely agree with that. Which is why I am trying to build a large rental income. Why kill the goose that lays the golden eggs right?

[monnchew]

Wow, it looks like I've totally shot myself in the foot.  Would my situation look any different if I had this established in a LLC or something of the sort?

Well I do have to say, I actually went out and did something, but is there a better plan of action to accumulate wealth within real estate?  I hear of the horror stories in rentals so that is why I went to rehab, but now I see the horror of taxes.  Any suggestions?

Thanks for your help.

[henryinma]

The LLC wouldn't really help you, that's just to limit your liability. Another possibility would be to do this in a self directed IRA or Roth IRA. Probably a Roth IRA would be better as the gains would be tax free. You still pay taxes up front though. Of course you don't really get to use the money til you hit retirement age. Just hope you don't have a loss as you can't deduct any losses just as you don't get taxed on gains. You should consult an accountant to figure all this out.

I believe the horror of taxes are about 100%, the horrors you hear about rentals make up only a small part of the total rental market. I've got 9 units right now and currently none of them are in the horror mode, but I do have a couple that are a little slow paying. None are at the eviction point yet. Hopefully it's just because of the holidays and things will return to normal by February.

[monnchew]

Henry, thank you so much for the help.  I really do appreciate it.

Now I have another question for you .

How do you buy your rentals?  Do you rehab them and then find your tenants, find landlords in distress, etc.?   If you do rehab them, how do you find the money to put into fixing them or bringing them upto code without dipping into your own pockets?  Are there lenders that will help you?

Sorry about that.  One question jumped into five, but it sounds like you are doing what I would love to be doing.

Brian

[henryinma]

I just buy them the regular way. My first one I just found through a broker, it was an estate sale and it had fallen through a few times. Didn't do any of the guru things, just a regular deal with cash out of my pocket. Most of the things they talk about doesn't really happen on a regular basis, they're talking about things that are nice to get, but tend to be the exception rather than the rule. My last one I found myself as a realtor. Got my own commission and it was priced aggressively. Turns out the owner had a sick wife and needed to cash out.

As for repairs, mine did need a little of it and I had to dip into my own pockets to do it. I'm not really into the whole 100% financing, when you do that, you find that the lenders tend to make a lot of the money and you do a lot of the work. They don't really seem to mention that in those seminars also.

Like most businesses, it takes money to make money. You can do it without money, but you tend to make less and I don't think there's any way around that.

[monnchew]

Thank you so much for your honesty.  It really sounds like you are an advocate for rental property.  It's nice to have a refreshing view of rentals.

I think I will begin to tap into the rentals, but I need to have some upfront cash or surplus inorder to go full board.  This is where the rehabs will come into play.  Do you have any other suggestions.

Also, I have never read or went to a seminar for this stuff, but it sounds like they are not very worthy of the time.  Is there anything to read or explore to help me learn the "realistic" way?

Thanks again.

[john-e]

If you are looking for a real fluff free book about real estate investing I would recommend "The No-Nonsense Real Estate Investors Kit" by Thomas J. Lucier.  He really gives some great tips on developing a successful REI business with his personal experiences.  He is the real deal, no BS no fluff.

[dwj469]

Himonchew rental property I believe is the true way to building wealth in real estate. Its takes time and hard work but its worth it. Just dont give up...

[mcwagner]

rehabs (flips) are never capital gain property.  they are always ordinary income, taxed at marginal rates and subject to self employment tax.  

they are considered the same as having a business that sells inventory, only the inventory is houses.

If you chose to leave the cash in the company, doing the deals inside an LLC taxed as a corporation would lower your total tax bill considerably.  Once you pull out the cash you would be taxed on dividends, but this might be lower than what you're going to pay doing the rehabs on your 1040.

[henryinma]

Thank you so much for your honesty.  It really sounds like you are an advocate for rental property.  It's nice to have a refreshing view of rentals.

I think I will begin to tap into the rentals, but I need to have some upfront cash or surplus inorder to go full board.  This is where the rehabs will come into play.  Do you have any other suggestions.

Also, I have never read or went to a seminar for this stuff, but it sounds like they are not very worthy of the time.  Is there anything to read or explore to help me learn the "realistic" way?

Thanks again.

I think most books are pretty realistic, some are better than others, most of them say the same. The latest one I read that I liked was Landlording on Autopilot. Pretty good, but some of the techniques mentioned there won't work in my state and he also prefers single families, but in this state the numbers don't work. On a per unit basis, they're probably 50-80% more expensive than a unit in a multi.

I've never gone to a seminar. Most of them are there to get you to go to another one. I remember reading one article where the guy had spent 30k on them and felt that he just need one or two more before he was ready to go ahead and do it. He should have just spent that 30k on a downpayment on a property. It's one thing for someone to tell you how to do it, it's another thing if you have the personality and the skills to execute what was taught.

[d_sbrown]

I just started a new thread, so I apologize for also resurrecting this one, but I found it with the search function, and it had good info.


mcwagner wrote,

"rehabs (flips) are never capital gain property.  they are always ordinary income, taxed at marginal rates and subject to self employment tax. 

they are considered the same as having a business that sells inventory, only the inventory is houses.

If you chose to leave the cash in the company, doing the deals inside an LLC taxed as a corporation would lower your total tax bill considerably.  Once you pull out the cash you would be taxed on dividends, but this might be lower than what you're going to pay doing the rehabs on your 1040."

I have a friend that just rehabbed a house in about 40 days, made 25k, and is being advised by multiple people, accountant, realtor, lawyer, that he can 1031 the "short term capital gains".  According to your post, he is getting bad advice?  I respect your posts alot, and I had always had it explained to me like you said, but he has been hearing the opposite from a lot of sources.

Thanks,

DB

[tatertot]

My memory is saying that there are holding periods required on 1031 properties.

The properties do not have to be rentals, they just have to be investment properties. For example, you can 1031 bare land.

40 day holding to do a 1031?  I would have said no, but both a lawyer and accountant are saying yes? Maybe he misunderstood what they were saying.  You know, you can look the law up online and see what the actual law says. IRS should have the terms on their website, too.

[BLL]

A 1031 exchange doesn't apply to property primarily held for sale.

If he used a c-corp, he could use the profits to fund an employee benefit program. The corporation gets a tax deduction and he gets tax free use of the benefits.