When you take out a hard money loan, bridge loan or investment property loan to buy a flip, you do it with one goal in mind: to make a profit.
In the process of your rehab, many factors will conspire to eat into your profits. Weather. Time. Unreliable vendors. The list goes on. But, few things eat away as much of your profits as taxes; the more you make, the more you pay.
One of the most effective ways to protect your profit margin is to find legal ways to minimize your taxes. We’ve identified five proven ways to minimize your tax exposure – so you can keep more of the money that you’ve worked so hard for.
1. Maximize Your Deductions
You’re fully aware that drywall, flooring, tile, paint and other hard costs are tax-deductible. So are outside labor costs. But don’t stop there.
Do you have a home office? Do you drive your car to and from the project site? Does that car use gas? Will you be paying any closing costs when you sell? Did you pay interest from a hard money or bridge loan?
Not all of your deductions are related to the renovation. Broaden your scope and see all the costs that go into your flip. Then, make all the deductions you’re entitled to.
One pro tip: Open a dedicated checking account and/or credit card specifically for deductible expenses. At the end of the year, you’ll have one simple report that organizes everything for you.
2. Put Profits Into Your Next Property
The IRS has a rule called Section 1031. Basically, it says your flip profits aren’t taxed as profits — if you turn around and put them toward the purchase of another flip.
So, let’s say you make $50,000 profits on a flip. That’s taxable. But if you immediately put that toward the purchase of a new property, it’s not taxable… at least, not this year.
Taking the profits of one flip and rolling it into another is a great flipping tactic. It will enable you to grow your flips from $100,000 per property... to $200,000... to $300,000– all while minimizing taxes.
A word of warning: you aren’t avoiding taxes. You’re deferring them. Eventually, you’ll end up paying taxes when and if you sell the properties you invested your monies into using a 1031 tax deferral exchange. But by deferring taxes and putting your money to work for you, you’ll come out ahead in the long run. There is, however, one notable exception: when you defer profits to invest in a rental property you may be able to defer taxes long-term.
3. Keep the Property for a Year or More
Should you flip — or flip and hold? By holding, you can gain revenue from renting. You can also reduce your tax rate. An immediate sale could be taxed at personal income rates (plus FICA) that can easily climb over 25% and beyond, while a deferred sale would have a capital gains tax rate of just 15%.
Of course, you need to factor in any costs involved in holding your property, such as interest from a hard money loan and property taxes. But, when you weigh the potential rental income and tax savings, holding a property can increase the ROI from your flip.
4. Offset Losses With Profits
Losses happen in any type of business. When they do, savvy entrepreneurs or real estate investors know how to use those losses to help minimize taxes on other areas of their business.
Use a loss on one property to offset the profits from another flip — and in the process lower your taxes. Nothing totally alleviates the sting of a big loss. But if you can use that loss to reduce taxes on another flip by $5,000 or so, it does help ease the pain.
5. Talk to a CPA Who Is Experienced With Flips
Should your business be structured as an LLC, C Corp or S Corp? Do you have an IRA or other retirement vehicles that enable you to defer taxes? Do you have an investment portfolio that you can leverage to purchase or finance properties?
A qualified CPA can help any business find ways to reduce taxes. By finding one who has also worked with real estate investors or house flippers, you’ll have a valued advisor who can help you fine-tune the way you conduct your day-to-day business.
As you know, house flipping is no job for slackers. You work hard and deserve to take advantage of all the tax breaks available to you. In the “9th inning” of the tax year, it can be tempting to tear through your taxes at lightning speed while eyeing the next deal on your desk. With a little due diligence (and some help from a great CPA) you can save yourself thousands of dollars in taxes and put it right back into your business.
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