Q: What are the options to avoid paying a significant amount of taxes on a flip profit of approximately $60,000 each?
A friend and I plan to purchase a property from an individual who owes taxes on it and cannot pay them. We would purchase it for $15,000 and plan to invest $30,000 to renovate it. I have read about short term gains and taxes owed when owning it for less than a year, 1 year or no taxes if it was lived in for 2 years? If owned less than a year I read that it is subject to personal income tax and a 15.3% FICA? Between 1-2 years it seems the taxes are capped around 20%?
What are the options to avoid paying a significant amount of taxes on a flip profit of approximately $30,000 each ($60,000 total). Would renting it out for a year and then selling help avoid the 15.3% FICA tax? Would starting an LLC be a huge hassle for this process or worth it?
A:
You've successfully confused all the tax rules at one time. I'm a little impressed.
1. Personal residence exclusion is not an option unless you want to move into it and live there as your primary residence for at least 2 years.
2. A house is a capital asset so if you own it as an investment for 1 year or more you would receive long term capital gain treatment 0, 15, or 20% rate vs the ordinary income brackets which are higher. If you own it for less than one year you would pay under the short term capital gain rates which are the ordinary income rates.
3. If you're in the trade or business of house flipping you don't have the option of using the capital gain rates you would pay ordinary income on all gains and self-employment tax on all gains (What you called FICA) and the property would be held as inventory instead of as an investment.
4. The first way to minimize tax is to keep all your receipts, mileage logs, and other documents showing the amounts spent to make the property ready for sale or to maintain the property. What you can deduct depends on the purpose of the property; is it personal, a business, or an investment. Second option, if it's a business, is a 1031 exchange which has very specific rules and procedures but essentially you trade your business real estate for a another business real estate that costs the same or more and you defer payment of tax. Those rules were heavily effected by the TCJA passed in 2017 so be careful what you read online.
So in summary it depends. I would suggest hiring someone ASAP, especially if you're going to be doing this over and over. Hiring a professional now will save you a lot of headache and money in the future. That person ca be an attorney, accountant, cpa, whatever; as long as they know the tax rules.
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