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