HERE IS A LOOK AT THE TAXES YOU WOULD BE OBLIGED TO PAY IF YOU WERE SELLING PROPERTY IN YOUR PERSONAL NAME
By selling real estate titled in your name or the name of a “pass-through” entity (LLC or “S”-Corp) you could pay as much as 60% of the income you receive from the sale in taxes. Those taxes include but are not limited to capital gains taxes, self-employment taxes, Alternative Minimum Tax as well as state and federal income taxes. Adding insult to injury, when you sell real estate titled in your own name or the name of a “pass-through” entity, many of your “real estate business expenses” will not be deductible when you file your 1040 tax return.
INCOME TAXES REPORTED ON YOUR 1040 TAX FORM
The tax effect of selling property as an individual or the name of a “pass-through” entity is that profits made from the sale of real estate are added to the income you report on your 1040 tax return. On the other hand, any losses from the operation of the property are deducted from your 1040 tax return (assuming the losses are not limited by IRS and state passive loss rules). Should you be a high-income earner to begin with, adding the income from the sale of a property to your 1040 tax return could be financially devastating. Likewise for your state tax burden as well.
CAPITAL GAINS TAXES
There Are Three Holding Periods For Capital Assets Sold: Those held for one year or less are considered short-term and are taxed at your ordinary 1040 income tax rate. You'll simply pay taxes at your "normal" 1040 tax rate on those gains (anywhere from 10% to 35%). This could be a “killer” should your taxable gain plus other 1040-income push you into the highest tax bracket. NOTE: Most sales of “flipping” property will fall into this category.
Those held for more than one year are considered long-term, and will be taxed at the rate of 5% for those individuals below the 25% ordinary income tax rate and 15% for those individuals above the 25% ordinary income tax rate, you will receive a tax break on the sale of those assets while those held for more than five years are considered "super-long-term" and are taxed at an even lower rate than long-term gains.
Computing Your Tax Bracket: One very important point to understand about ordinary income/capital gains is that to determine your normal tax bracket for capital gains purposes, your capital gain income is added to your regular income and you use the total (not just the portion related to your earned income). Then you’re able to use Schedule D to compute your tax.
Don't think that if you have $100 in other income and $1 million in long-term capital gains that you're in the 15% bracket -- and that your $1 million in long-term capital gains will be taxed at the preferred 5% rate. It simply doesn’t work that way. You have to add your $1 million to your $100 and then look at your tax bracket.
THE ALTERNATIVE MINIMUM TAX
Especially vulnerable to the AMT tax are people with income over $75,000. Most vulnerable are taxpayers with several children, interest deductions from second mortgages, capital gains, high state and local taxes and incentive stock options.
Here’s how it works: In effect, you are simply adding back some tax deductions and income exclusions to your regular taxable income to arrive at your alternative minimum taxable income. Here is where the middle class gets soaked. First you have to add back your personal-and dependant-exemption deductions ($3,200 each in 2005, $3,300 each in 2006), then your standard deduction if you don’t itemize $10,300 for joint filers in 2006; $5,150 for singles in 2006). You also lose your state, local and property tax write-offs, as well as your home equity loan interest, if the loan proceeds are not used for home improvements. The AMT also ignores some itemized deductions, such as investments expenses and employee business expenses, and some medical and dental expenses.
Let’s do the math: Under the AMT, adding $1,000 of long term capital gain can increase your taxes buy as much as 22%. 15% is the gain portion and the remaining 7% is the AMT Tax (equaling 22%).
SELF-EMPLOYMENT TAXES
Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. (See IRS Code Section 1402 and/or IRS Publication 533). Publication 533 states that you are self-employed and must pay self employment taxes if:
You Carry On A Trade Or Business: A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit.
You Are A Sole Proprietor: You are a sole proprietor if you own an unincorporated business by yourself or owned by a husband and wife.
Real Estate Rent: Rental income from real estate is NOT included in earnings subject to SE tax UNLESS You provide services for your tenants (you personally manage your properties) or You are a real estate dealer.
REAL ESTATE DEALER STATUS
A real estate dealer is defined as: “An individual who is engaged in the business of selling real estate with a view to the gains and profits that may be derived from such sales.
A negative consequence of the dealer status: If you are considered a real estate dealer, you become ineligible for Section 1031 tax deferred exchanges becaukse the property owned is considered inventory.
CONFUSED YET? MOST PEOPLE ARE BY THIS POINT.
READ ON AND SEE HOW TO LEGALLY ELIMINATE THESE TAXES.
READ ON AND SEE HOW TO LEGALLY ELIMINATE THESE TAXES.
HERE IS AN EXAMPLE OF THE TAXES YOU WOULD PAY SHOULD YOU SELL A PROPERTY TITLED IN YOUR NAME OR IN THE NAME OF AN LLC OR “S”-CORPORATION AT THE TIME OF SALE
The premise for this example: You received a check for $49,000.00 at the closing of the escrow for a “FLIPPED” property you purchased and that you held for less than 12 months when you sold it. The property was titled in your name or in the name of an LLC or “S”-Corporation at the time of sale and you are a married person jointly filing a 1040 tax return with your spouse at tax time (you are in the 15% tax bracket).
NOTE: STATE AND LOCAL TAXES NOT INCLUDED IN THE COMPUTATION.
ESCROW CHECK $49,000
LESS
Self-Employment Taxes (15.3%): (--$7,497)
Capital Gains Taxes (15%): (--$7,350)
Total Federal Tax Obligation from the income received from the sale: (--$14,847)
AFTER TAX PROFIT (FEDERAL TAXES ONLY): $34,153
NOTE If you were required to pay Alternative Minimum Tax, the figures shown above would be even more devastating!
WANT TO MAKE THESE TAXES DISAPPEAR?
Making the taxability disappear: The secret to making the taxability disappear is selling your property in a legal entity controlled by you. One that will afford you exceptional “write-off” capabilities, maximum asset protection and absolute flexibility while at the same time reducing or eliminating the taxes associated with holding and selling real estate.
Internal Revenue Code: Transferring property into your wholly owned “C”-Corp is known as a Section 351 (IRS code section) contribution of property transferred to your controlled entity on a tax-free basis, as no sale to an outside party has occurred.
YOU SAVE BIG $$$ BY SELLING YOUR PROPERTY THROUGH A “C”-CORPORATION!!!
“C”-Corporations are entitled by law to many tax deductions that are not available to individuals, LLCs or “S”-Corps. Additionally, “C”-corporations have a lower federal tax rate at all levels of income up to $250,000 when compared with individuals tax rates for the same level of “TAXABLE” income. (“C”-Corporations pay only 15% tax on the first $50,000 dollars of PROFIT (this is the amount of money left over after all expenses are paid).
NOTE: Individuals receive income, pay taxes and then buy things with the “after tax” money. Conversely, “C”-Corporations receive income, buy things with “pre-tax” dollars and then pay taxes on any money left over.
CORPORATE CAPITAL GAINS
Corporations (in the real estate business) are NOT subject to any capital gains tax liability from the sale of real estate. Instead, corporate gains are included with the rest of the corporate income and therefore become part of the ordinary income of the corporation. Further, the IRS Code makes no distinction between short or long term gains either.
IRS DEALER TAX STATUS AND SELF-EMPLOYMENT TAXES:
Interestingly, “C”-Corporations are NOT subject to dealer status issues or self-employment tax.
HERE IS AN EXAMPLE OF THE TAXES YOU WOULD BE OBLIGED TO PAY SHOULD YOU SELL A PROPERTY TITLED IN THE NAME OF A NEVADA C-CORPORATION AT THE TIME OF SALE
The premise for this example: You received a check for $49,000 at the closing of the escrow for a “FLIPPED” property your held by your C-corporation for less than 12 months when the corporation sold it. The property was titled in the name of your C-corporation at the time of sale.
NOTE: STATE AND LOCAL TAXES NOT INCLUDED IN THE COMPUTATION.
ESCROW CHECK $49,000
LESS
C Corporation would receive 100%: $49,000
Self-Employment Taxes (15.3%): (NOT APPLICABLE) (-$0000)
Capital Gains Taxes (15%): (NOT APPLICABLE) (-$0000)
Total Tax Obligation: Because the business of the C-corp is buying and selling real estate, the total amount of $49,000 would be classified as “ordinary business income” that can be spent by the corporation to pay for expenses such as: vehicles, health and life insurance, retirement plans and even to purchase additional real estate. Additionally, the C-corp would be required to pay taxes ONLY on the NET amount remaining in the account at the end of the tax year (if any). Should that amount NOT exceed $50,000, the corporation would be taxed at 15%. However, it is possible for the C-corp to “ZERO OUT” its net income and pay NO taxes at all.
AFTER TAX PROFIT (AFTER ZEROING OUT FEDERAL TAXES) $49,000
HERE IS A COMPARISON OF THE TAXES YOU WOULD BE OBLIGED TO PAY SHOULD YOU SELL A PROPERTY TITLED IN YOUR PERSONAL NAME OR IN AN LLC OR “S”-CORP OR THE NAME OF YOUR NEVADA “C”- CORPORATION AT THE TIME OF SALE
The premise for this example: You received a check for $49,000 at the closing of the escrow for a “FLIPPED” property held for less than 12 months when it was sold. The property was titled as shown below at the time of sale (NOTE: state and local taxes not included in the computation).
INDIVIDUAL NEVADA LLC, S-CORP C-CORP
ESCROW CHECK $49,000 $49,000
LESS Self-Employment Taxes (15.3%): (--$7,497) (-$0000)
Capital Gains Taxes (15%): (--$7,350) (-$0000)
Total Federal Tax Obligation from the income received from the sale: (--$14,847) ($0000)*
AFTER TAX PROFIT (FEDERAL TAXES ONLY): $34,153 $49,000**
Total Corporate Federal Tax Obligation: Because the business of the C-Corp is buying and selling real estate, the total amount of $49,000 would be classified as “ordinary business income” that could be spent by the corporation to pay for its ordinary business expenses such as: vehicles, insurance, retirement plans and even to purchase additional real estate. Additionally, the C-Corp would be required to pay taxes ONLY on the NET amount remaining in the account at the end of the tax year (if any). Should that amount NOT exceed $50,000, the corporation would be taxed at 15%. However, it is possible for the C-Corp to “ZERO OUT” its net income and pay NO taxes at all.
**Corporate AMT: The Corporate AMT tax is on the chopping block in 2006. However, unitl it is actually repealed it may apply to those corporations earning in excess of $7.5 million in revenues over a 3-year period. In other words, shouldn’t apply to most of us.
Tax profit after zeroing out federal taxes: Zeroing out your corporate tax obligation should not be a problem for real estate investors should they take advantage of the strategies Priority Services Group will teach you.
Investigate our Escrow Program to find out how these strategies can benefit you. Contact Priority Services Group for a free consultation.
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