Today TaxMama hears from Gaetano in Pennsylvania, who asks “If an individual purchases an old home with the intention of fixing it up (significantly or substantially) and then turning it over (selling it), is this treated as a capital gain asset or as ordinary income? The individual is not in the construction business but works full time in an unrelated business.”
That’s a very interesting question.
Here are some scenarios about how to do this to keep your taxes low or non-existent.
1) Buy the home and move into it, making it your personal residence. If you are married or have a partner in this venture, move in together.
That way, if you buy something in a good area that, once you fix it up will go up significantly in value, you have up to $500,000 worth of profit that you can absorb without paying taxes at all.
The trick? Stay in the house for two years and your $250,000 (each) personal residence exclusion will kick in – and you’ll pay no taxes.
Starting small, you probably won’t exceed $250,000 profits on the first couple of houses. So you can do it alone. But as you progress, you’ll be able to afford more expensive homes – and higher profits.
2) You don’t want to live in it. Fine. Keep the house for one year and don’t rent it out. Your profits will be long-term capital gains, taxed at a maximum of 15%, instead of at your highest tax rate.
(Plus your state, of course.)
3) You don’t want to live in it, and you want to flip it quickly – in less than a year. No problem. Just beware. All your profits will be short-term gains, taxed at your regular tax rate. This is probably not a big deal for the first house. Maybe not even the second, since, if you start small, your profits won’t be more than $10,000 – $30,000. But, once you start generating higher profits, consider holding the house for at least a year.
And in all cases, compute the taxes saved vs the extra mortgage payments you have to make to hold the property for the 1 year for capital gains, or two years, to avoid the taxes altogether.
This can be an excellent way to build a tax-free income for life, without roll-overs or complicated tax structures. Just pull out some of the profits each year – and use the rest to remodel the next house.
If you pick up the skills to do much of the work yourself, your costs won’t be high at all, and the work will be done well. Now, go out and build your future!
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