Because of their short turn around, the profits from house flips are subject to the regular income tax rate, which could go as high as 37 percent. If you’re self-employed, you have an extra burden-FICA, which could add another 15 percent to your effective tax rate. We haven’t even mentioned state taxes yet
So, if you’re a successful flipper how high could your tax rate be?
Consider a house flipper located in Taxifornia, say he earns 500 K each year solely from flipping houses. His income puts him in the top federal tax bracket, and because he’s self-employed he’ll also need to pay FICA, so his federal rate is 52.3 percent. We can’t forget state taxes; in California, the state will collect 11.3 percent of his income. So effectively 64 percent of his profits on any flip will go toward taxes.
Say he wants to flip a house, which could earn him 35 K in profits. 22 thousand dollars will end up going to Uncle Sam and the hippies in Sacramento.
Are there ways for our poor flipper to beat the system without risking incarceration?
With Arizona Hard Money Loans; consider using these tactics to lower your tax burden.
• Maximize deductions- Thankfully all of the soft costs involved in your project are deductible. You can deduct the cost of materials, labor and even the interest payments on your loan. To maximize deductions deposit all your hard money financing into a separate business account this will allow you to keep track of all your expenses so that you can deduct every penny you spend on your project come tax time.
But what if you want to pay a lower rate, well there is another method that can effectively cut your tax bill in half-
• Fix and Hold- If you hold onto a property for 13 months you’ll end up paying the lower capital gains rate, and you won’t need to pay those awful FICA taxes. Let’s see what happens if our flipper decides to hold onto his property for 13 months, rents it out for 9 of those months and charges his tenant a rent of a thousand dollars a month:
• He’ll pay 20 percent in capital gains taxes, and 11.3 percent in state taxes, making his effective rate 31.3 percent.
• 35 K-11 K in taxes=24 K in profits+9 K in rental income=33 K in total profits.
By using the fix and hold strategy, he’s more than doubled his profits on this deal, and he’s even earned extra rental income.
One caveat if you’re going to employ a fix and hold strategy is you need to be sure that your loan has a 13-month term. Unfortunately, most hard money deals don’t last that long. So, if you plan to employ the fix and hold strategy to lower your tax bill, you need to get long term hard money financing, before you start your project.
Regardless, if you maximize deductions or employ the fix and hold strategy, you can, beat the system and earn and earn a higher return from your next flip.
Level 4 Funding LLC
Hard Money Lender
Hard Money Loans
Hard Money Loan
Arizona Tel: (623) 582-4444
Texas Tel: (512) 516-1177
Dennis Dahlberg Broker/RI/CEO
NMLS 1057378 | AZMB 0923961 | MLO 1057378
22601 N 19th Ave Suite 112 | Phoenix | AZ | 85027
111 Congress Ave | Austin | Texas | 78701
About the Author: Dennis has been working in the real estate industry in some capacity for the last 40 years. He purchased his first property when he was just 18 years old. He quickly learned about the amazing investment opportunities provided by trust deed investing and hard money loans. His desire to help others make money in real estate investing led him to specialize in alternative funding for real estate investors who may have trouble getting a traditional bank loan. Dennis is passionate about alternative funding sources and sharing his knowledge with others to help make their dreams come true. Dennis has been married to his wonderful wife for 43 years. They have 2 beautiful daughters 5 amazing grandchildren. Dennis has been an Arizona resident for the past 40 years.