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Flipping vs. Assignments


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#1 option8

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Posted 01 March 2004 - 09:14 AM

I've been looking for a succint answer to this question.

What is the tax implication difference between a flip and a assignment?

For the purposes of my question I want to get a few definitions straight.

1) a flip is a sales contract where I go on title either as an out right purchase or sub2, and then re-sell it to another buyer. In this scenario, I would cause a title seasoning issue and would be "guilty" of dealing.

2) an assignment is a contract where I have a lease option or pure option, do not cloud the title in any manner, create no seasoning issues and simply assign my contract to a substitute buyer for a fee (perhaps for services rendered)

Is this the correct terminology for these transactions? Are my definitions correct?
Could I be considered a dealer in either of these 2 scenarios? or Is the "Flip" the only one where I am considered a dealer?

Any help that can be provided is greatly appreciated.

option8

#2 MichaelC

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Posted 01 March 2004 - 01:00 PM

Is this the correct terminology for these transactions? Are my definitions correct?

Option8, I concur with you on your definitions of flip and assignment. I think you make an understandable distinction.

Could I be considered a dealer in either of these 2 scenarios? or Is the "Flip" the only one where I am considered a dealer?

That's a very good question, and one I know I shouldn't venture a guess on. The "dealer" question to me has always seemed vague and haphazard as to how or if it may be enforced. I'd welcome a definitive answer on this, too.

#3 pinkerton

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Posted 02 March 2004 - 12:22 AM

Alright, alright...I know its hard to believe, but I have to do some research on this one...be back. :D

Mike P. :(
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#4 mpine

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Posted 04 March 2004 - 01:12 PM

Mike,

So have you found out the answer we are all longing for?

Thanks,

Mike
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#5 MichaelC

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Posted 09 March 2004 - 09:25 PM

I've been slow on the draw with this question from the get go. In my opinion this has always been a tax related question and should have been treated as such from when it was originally posted. My oversight; my apologies.
In the meantime, I contacted our Tax Man regarding this question and Dave T was good enough to respond with the following:

The IRS does not label anyone a dealer. Instead, each individual transaction is evaluated to determine if it is a dealer disposition.

Dealer dispositions are:
  • Not eligible for installment sale tax treatment. Instead, all profit from a dealer disposition is fully taxable -- as ordinary income -- in the year of sale. Capital gains tax treatment does not apply.
  • Not eligible to participate in a 1031 tax-deferred exchange.
  • Treated as an active business activity. In the absence of a taxable business entity, income and expenses related to the "business" and profits from dealer dispositions are reported on Schedule C AND self-employment taxes are calculated on Schedule SE.
Investors:
  • Can defer capital gains with qualified 1031 exchanges.
  • Can defer capital gains with installment sale tax treatment.
  • Can take advantage of the lower long term capital gains tax rates for investment property held at least one year.
  • Are not subject to self-employment taxes.
  • Report their taxable profits on Schedule D, and their passive rental income on Schedule E


Dave then followed up a short while later with this:

I suppose the real answer to the question can be summarized as:
  • Investment property is property held for the production of income or for future appreciation.
  • Dealer realty is property held primarily for resale to customers.
Investment property tax treatment is the same as for investors in my earlier message. Dealer realty tax treatment is the same as for dealer dispositions in my earlier post.

Determining the taxpayer's real intent is not really the issue for the IRS. A pattern of activity that suggests one is acting as a dealer to real estate is sufficient for the IRS to tag all real estate sales and exchanges as dealer dispositions. It is up to the taxpayer to prove that his intent was really to hold these properties for a qualified investment purpose. In other words, in tax court, the taxpayer is wrong and must prove his entitlement to the tax treatment taken.


A big thank you to Dave for his usual insightful reply.

#6 pinkerton

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Posted 09 March 2004 - 09:45 PM

I wish I could take credit for Dave's answer, but I can't...this clears up an area that not many of us know...but should. :blink:

Great job, Dave.

Mike P. :blink:
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#7 option8

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Posted 10 March 2004 - 07:44 AM

Folks

this has always been a tax related question and should have been treated as such from when it was originally posted


Sorry I posted this in the wrong place!

Thanks for everyone working so hard on this.

So, in my examples the following would be true.

Flips would cause transactions to become "dealer" transactions.
Assignments, which are never held at all (never go on title) still are not long term hold properties, so would still be regular income and would benefit from none of the investor loopholes. Fundamentally, as you say, this is an issue of which business entity to use for which type of transaction.

The bottom line as I see it:

-One entity to hold (to start with---more maybe necessary later for asset protection)
-One entity for assignments or flips

By segregating like this, you get the corporate tax benefits for all your transactions and the two entities never "pollute" one another

I've heard folks say this, but didn't really understand why. Now I get it and will structure my entities to address this.

DaveT, Michael, pinkerton, you're the best! That's why I love this board!

Thanks
option8
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#8 pinkerton

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Posted 10 March 2004 - 08:19 AM

Boy, I feel strange over here in the tax forum...kind of like a lawyer in an H&R Block training class. :D

option8, I'm not sure you would need different "entities" to keep these transactions separate...what about "subaccounts" within your general LLC account where you could segregate transactions? This would be more flexible and may be easier to deal with from a book keeping standpoint.

I would bounce that approach off your accountant...or maybe Dave can come to the rescue again (lookin' good in that white hat, Dave :o ).

Mike P. B)
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MC--Do you think this string should be pinned? There's some "nitty gritty" information here that everyone should get their arms around.

#9 MichaelC

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Posted 10 March 2004 - 09:48 AM

MC--Do you think this string should be pinned? There's some "nitty gritty" information here that everyone should get their arms around.

Yes, I do.....

#10 Dave T

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Posted 18 March 2004 - 08:05 AM

option8, I'm not sure you would need different "entities" to keep these transactions separate...what about "subaccounts" within your general LLC account where you could segregate transactions?  This would be more flexible and may be easier to deal with from a book keeping standpoint.

Mike,

You are absolutely correct. Careful bookkeeping should be adequate to segregate your dealer dispositions from your investment activity and therefore avoid having your dealer dispositions taint your long term capital gains tax treatments.

I see the issue here as one of asset protection and limiting liability exposure. If I were to operate within one business entity which conducted both dealer activities and investment activities, would all of the assets held by the business entity be exposed to liability in the event of a lawsuit?

If the answer is yes, then it would seem prudent to shield your long term investment holdings from exposure to a lawsuit arising from your dealer activities by conducting each activity from within a separate business entity.

Dave T

#11 option8

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Posted 18 March 2004 - 08:58 AM

Dave,
Just for clarification... Are you saying 2 different entities for the best protection or one entity with 2 (or more subaccounts) is sufficient.
Thanks
option8

#12 Dave T

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Posted 18 March 2004 - 10:00 AM

Dave,
Just for clarification... Are you saying 2 different entities for the best protection or one entity with 2 (or more subaccounts) is sufficient.
Thanks
option8

Depends upon your focus.

If having your dealer dispositions taint your investment dispositions is your ONLY concern, then one business entity with separate subaccounts and good documentation should be adequate.

If you are ALSO concerned with limiting your liability (your asset exposure) in the event of a lawsuit, then I suggest using one business entity for your rental property holdings, and another separate and distinct business entity for your dealer activities.

Good accounting practices within a single business entity only address an IRS issue. Two separate business entities also address the IRS issue with the additional asset protection features that limit your liability in the event of a lawsuit arising from your dealer activities.

Just my opinion. I am not an attorney.

#13 option8

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Posted 18 March 2004 - 11:44 AM

Thanks Dave,

In my book, it's better to be safe than sorry, so I'd like to address both issues....IRS and liability. If 2 entities does this, then great. I'd rather get this in place sooner than later.

option8

#14 pinkerton

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Posted 18 March 2004 - 04:54 PM

STAGE DIRECTION: The Legal Eagle enters stage left playing the role of the "Devil's Advocate." :ph34r:

Now is when you want to look at those papers you filed with the Secretary of State when your LLC was formed. They're called "Articles of Organization" or something similar. Somewhere in those articles you'll find a "statement of purpose."

If the statement of purpose is narrow...e.g. "to engage in real estate investing."... then Dave definitely has a point on his two entity theory as the LLC's protection would only apply to investing, not dealing. :)

On the other hand, if the statement is general (as it should be)...e.g. "to engage in any lawful business for which limited liability companies may be organized in this state."... then a good argument can be made that one entity with proper subaccounts deals with both tax and liability issues. ;)

That being said...separate entities can't hurt...they can just be expensive. Of course so can having your personal assets attached after a judgment. B)

THIS IS NOT LEGAL ADVICE, but a properly drafted general purpose statement in the Articles of Organization should deal with the issue. This approach also follows the "KISS Principle"--Keep it sweet and simple.

STAGE DIRECTION: The Legal Eagle exits stage right after having played the role of "The Devil's Advocate." :ph34r:

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#15 Gene

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Posted 12 April 2004 - 12:35 AM

My local REI association met last week and one of the speakers was a CPA. One main topic of her presentation was entity selection. I left this meeting feeling very confused. This confusion was due to my assumption that an LLC was the proper legal entity for my lease purchasing business. The speaker stated that LLC’s are good for holding rental properties long term and S-corporations are better for quick flips or l/o’s.

This thread addressed some very good points. However, I wonder if the original question was completely satisfied. Option8 asked “What is the tax implication difference between a flip and a assignment?” Dave T. clarified the question stating that it is really a dealer issue. Bottom line…dealer property is not eligible for the same tax benefits as investment property. The thread then veered over to a discussion of how to keep investment and dealer property separate so that the IRS does not tax all transactions as dealer transactions.

I am wondering what entity will best satisfy our financial needs related to the dealer issue.

It is my understanding that an LLC will still be liable for self employment tax, where an S-corporation would not. SE tax is approximately 15% and this is in addition to the ordinary income tax that would be applied to our profits.

Does an LLC have other substantial benefits that outweigh the self employment tax issue? Am I missing something here?

Gene




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