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Summer

Capital Gains on a foreclosure purchase

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Dave T,

 

If a house is bought at a foreclosure auction For $150,000 ( the house has been appraised for $210,000) and it is re-sold right away to another seller at the full price of 210,000, what are the capital gains implications for this type of immediate sale?

 

Thanks.

Summer

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Property flipping is an active income business, and capital gains tax treatment does not apply.

 

If you did this either in your own name or in your LLC (disregarded entity), your $60K profit on the deal would be taxed as ordinary income at your marginal tax rate and subject to self-employment taxes (15.3% for FICA and Medicare combined). Self-employment taxes go away if you have at least $87,000 in other W-2 income. In this case, you would only be responsible for the Medicare tax on your flip income (less than 3%).

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Dave T,

Thanks for the clarification on this.

Summer

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Guest JOHN HASLACH, CPA, MST

If you do it infrequently, you could take the position you are an investor and not in the trade of business. If you are an investor, the gains, while taxed as ordinary income are not subject to SE tax. An alternative is to do your flips through and S Corp. It will allow you to control your SE tax.

 

John K Haslach, CPA, MST

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For the casual "investor", let's make sure that John's suggestion is also coupled with the risks inherent in taking that suggestion.

 

It would be fair to say that if you "do it infrequently" (property flipping), your audit risk might be lower, but if audited the IRS will most likely recharacterize your transactions as dealer dispositions as defined in Section 453(l)(1)(B) of the tax code. The problem for me is that if you "do it infrequently", you are establishing a pattern of activity that will eventually be recognized by the IRS as acting as a dealer to real estate, however infrequently.

 

I have extracted the pertinent language here: "The term 'dealer disposition' means any disposition of real property which is held by the taxpayer for sale to customers in the ordinary course of the taxpayer's trade or business."

 

I maintain that the word any in this definition means that even the infrequent property flip is a dealer disposition. In the absence of any other legitimate passive income activity, it would think it would be extremely difficult for one to sustain a claim of acting as an "investor" in this transaction. Remember that the IRS definition of an investor is much more narrow than the context that most of us are used to.

 

Now, change John's suggestion to "do it once", I believe your chances of sustaining your claim of acting as an investor are greatly improved and likely to succeed if audited.

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Again, thanks for your thorough answers to my question.

I will definitely keep in mind all of these points.

Thanks,

Summer

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