Don’t like the way your taxes look? You’re not alone. Most new real estate investors cringe when tax time comes around and their hard-earned money suddenly goes missing.
Fortunately, there are five strategies you can use to reduce your tax burden and save cash as a real estate investor:
1.) Make the Most of Deductions
Consider this technique obligatory. The other options below each have their own advantages and disadvantages, but deductions are essential for every business owner.
Almost all soft costs, such as labor and materials for renovations, are deductible. However, many rookie real estate investors overlook the less obvious soft costs, such as those on your HUD-1 settlement statement.
Do you have a workspace at home? Subtract for it! Remember that house flippers are classified as corporations, not as individuals. Therefore, you can deduct a portion of your rent or mortgage payment for your home office. You can also deduct some of your utility costs and any supplies and equipment for your home office.
Likewise, you should consider deducting travel and car expenses because you drive to and from the property, settlements, and other locations. Also, check into your mortgage or home loan for deductions. Often you can subtract mortgage interest at tax time.
Perfect record-keeping is the key to optimizing your deductions. Opening a company bank account will allow you to keep all of your business spending separate from your personal expenses. Then, when it comes time to submit your taxes, you’ll be able to deduct every penny you spend from that account.
2.) Use a 1031 Exchange
Section 1031 of the IRC (Internal Revenue Code) allows taxpayers to avoid paying taxes by engaging in a “like-kind exchange.” For real estate investors, this implies avoiding taxes by reinvesting gains from one flip in another.
Assume you take the profit from the previous investment property and use it towards a down payment on another property. Register it as a 1031 exchange, and the proceeds are tax-free for the tax year.
This is ideal for property investors who want to build up their house flipping income to acquire bigger deals and make more money. Investors may take advantage of the miracle of compounding profits by delaying their tax payment, without those pesky taxes eating up half of the earnings.
What’s the catch? When you stop spinning your money through deal after deal, you’ll eventually have to pay taxes, and you’ll genuinely want to pocket some of those earnings. Those additional profits may have put you in a higher tax rate by then.
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3.) Keep the Property for an Extra Year
Given the large disparity between ordinary income tax rates and capital gains tax rates, this alternative is scarcely a plot twist.
Aside from the tax rates, this income is classified as investment income rather than business income and is therefore exempt from FICA taxes. A more patient investor will pay less in taxes for holding onto a property for one year. After one year, the tax rate drops to ordinary income tax.
While you might think holding the property will end up costing you, it doesn’t have to. Another possibility is to rent the home out for a single tenancy before selling it. You buy it, refurbish it, lease it, and then sell it once the tenants have moved out.
This method has several advantages and disadvantages. In addition to the significantly lower taxes on gains, investors may be able to benefit from monthly cash flow even while the property’s value rises.
Appreciation, on the other hand, is far from certain. What if the property’s value drops rather than rises? It does happen, although infrequently.
Another possibility is that the tenants could cause harm to the home that you have just spent so much time and money remodeling. Not every renter is considerate of their landlord’s property.
Take into account the terms of your loan. A bridge loan is a short-term loan that is not intended for long-term rentals and is used to purchase and remodel a property. Aside from having a higher interest rate than a long-term mortgage, many bridge loans have a one-year duration limit. You don’t want to violate your loan terms or end up paying excessive amounts of interest.
Finally, remember that the longer you own a home, the slower your “money velocity” will be (how quickly you can turn over your investment capital to keep it working for you).
4.) Perform a Live-In House Flip
What if you plan to stay in the house for a year or more?
Doing a live-in house flip has many benefits. You can start by financing it with a homeowner mortgage, which is less expensive than hard money loans. While hard money loans are convenient and flexible for short-term flips, they are not suitable for long-term financing.
Second, you can conduct the repairs whenever you choose. The mortgage is no longer a business cost because you live there.
But, maybe most importantly, you can completely avoid paying taxes. The IRS doesn’t apply a capital gains tax on profits up to $250,000 for individuals and $500,000 for married couples if you have lived in a property for at least two of the previous five years.
Of course, if you wait at least two years between each flip, you won’t be flipping many houses! It can, however, be a terrific technique for anyone wishing to make the occasional flip, without scaling a house flipping business.
5.) Use Losses to Decrease Your Taxable Income
Informed real estate investors can considerably limit their risk of losses by conducting proper research, planning, and discipline. They are aware of the importance of due diligence at each stage of the property flipping process. They understand which upgrades add the most value to their homes and how to market their homes once they’ve been renovated.
At Connected Investors, we provide you with calculators and resources to help you determine the profitability of your next flip. Check out resources for fix and flip investors here.
However, in the worst-case situation, a loss will offset your other flips’ earnings. So if you were planning on keeping a property for more than a year, doing a 1031 exchange, or jumping through other hoops to avoid taxes, you might not need to do so this year if losses offset earnings.
Paying Taxes as an Investor
Real estate investors must make quarterly anticipated tax payments to prepay their taxes. To do so, investors must file a Schedule C form with the IRS every quarter (also known as the 1040 Profit & Loss Form). By January 15, April 15, June 15, and September 15, respectively.
While taxes are unavoidable, it does not mean that the tax rate is set in stone. As a wise real estate investor, you may reduce your tax burden by incorporating the five strategies listed above into your house-flipping business plan.
After all, the fewer taxes you pay, the more money you’ll have to put back into your business. The more you reinvest your gains, the faster you’ll be able to create wealth through house flipping.
The Takeaway
- Use PiN to locate houses to flip.
- Carefully research your options to reduce your tax burden
- Accurately determine your profits.
- Get a property investment loan at PrivateLenders.com.
- Check out our other resources! Visit our Smart Forum and download our free mobile app! The more you know, the smoother and more profitable your real estate investing business will be!
The post Best Tax Strategies For Flippers appeared first on Connected Investors Blog.
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