Before I begin, let me share with you the same disclaimer I share whenever I talk about taxation and other legal issues: I am not a CPA and I am not a lawyer. Anything I tell you here should be verified by your CPA or lawyer before you put it into practice. I just want to share with you what I have been told and what has worked for me. Okay?
Great. Then let’s get started. In today’s blog post, I wanted to share some valuable information about how to save on the taxes you pay each year.
As you do more and more deals, you will make more and more money. But because income taxes are based on your “income”, the more you make, the more you pay. Now, I am not anti-taxation and I do not believe in tax evasion. But I do believe in using the laws written by the IRS to legally and ethically keep more of the money that I earn. And I have found that, aside from being a great way to earn money, flipping land gives me some interesting tax breaks. While land doesn’t “depreciate” in value like properties with structures do, there are some laws in the tax code that I have personally taken advantage of. Let me explain a few of them:
1) As a long-term investment. If you purchase a piece of unimproved land with the intent of holding on to it for at least on year, the IRS views it differently than a “flipping” investment and will charge you taxes at a different rate (long-term capital gains rate). That means that instead of being charged 30% or more in taxes on your orofits from the deal you will only be expected to pay a rate up to 15%.
2) Understand your “cost-basis”. When you flip a piece of land for $10,000, you are not required to pay taxes on that $10,000. You are only liable to pay taxes on the “profit”. Why? The IRS encourages investment and doesn’t want to punish investors for stimulating the economy. So investors can subtract their “cost-basis” from their earnings and only pay taxes on what remains. Let’s say you spent $1,000 on the land you just sold for $10,000. The $1,000 is your “cost basis” and is tax-free. You are only legally required to pay taxes on the remaining $9,000 (90%). And if you sell with seller financing, that tax on 90% of your earnings from that deal continues as long as you receive payments from the buyer.
3) Take advantage of the “installment method” (seller financing). By accepting payments with interest over several years (and not accepting a lump sum) you can keep yourself in a lower tax bracket and pay a lower percentage on your earnings.
Some folks have asked me about the IRS rules on becoming a real estate “dealer” (which means paying taxes upfront on expected profits. The IRS rules state: “You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales.” There has been a lot of confusion about those words, and more than one legal case, but it seems that the IRS only takes issue with investors when they sell land with “improvements” – i.e. houses. But as long as they invest in raw land and sell it to individuals, investors shouldn’t run into any problems with “dealer” status.
4) Use of legal entities. Using a self-directed IRA, a C corporation, an LLC, a partnership – all can provide certain legal protection and tax advantages. Talk to a lawyer or CPA and find out which one can work best for you.
Flipping land can be a great way to earn more and pay less. In all my years as an investor, I have never paid more than 22% to 25% of my income to the IRS (even though I was in the upper section of earners). So why not make your investments work for you?