Typically, real estate investing is a passive activity. Profits are subject to income tax—not self employment tax. An active trade or business, on the other hand, is likely subject to the full 15.3% self-employment (SE) tax. Since a flipping or wholesaling business is considered an active business, house flippers may be subject to the full 15.3% self-employment tax, which can lead up to a $21,068 hit to your earnings. Same can be true for many Airbnb rentals.
Not every flipper or Airbnb landlord will benefit from an S Corp election taxation. However, enough do that you should consider it as an option. Let’s take a closer look.
Why the IRS may see flipping as active income
Some real estate investors aren’t really investors (at least according to tax laws). They are property developers who renovate and rehab. In other words, they’re flippers. Profits from real estate flipping may be subject to both income tax and self-employment taxes. Flipping is an active business. That translates to ordinary income taxes at your marginal rate as well as self-employment tax and/or payroll taxes. This depends on how the deal is structured. Compare flipping to buy and hold investing, where investors are relying on passive income.
Just as with any other active trade or business, an S Corp election may be a good way to save self-employment (SE) taxes. There are a few things flippers should know about organizing and defending their real estate portfolios. Chief among these is how to construct an asset protection strategy that adequately defends against lawsuits:
How frequently do you plan to make transactions?
Many flippers will have a property bought and sold inside of a year, for example. Certain entities are better for frequent transactions.
Licensing and other operations issues. A savvy house flipper may want to get a real estate license (or work with a team member who has one), even if doing so isn’t legally necessary. What’s best for you in terms of daily operations may come down to personal preference.
What percentage of business is your flipping activity? If you are exclusively a flipper, you will almost certainly require a different approach than an investor with only minor flipping activity—or who doesn’t rely on flipping transactions for profit.
It’s vital that those engaged in active real estate flipping find a way to limit inherent liabilities. For many flippers, the LLC with S Corp election helps square both the issue of liability and how to formalize the flipping business.
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