Use business expenses now or adjust Cost basis later?

[day2play]

I am in a 22% tax bracket, filing jointly with my husband who is still working. I have an LLC, and flip houses (rather slowly). I am thinking that it might be better to use my expenses on my house flipping project to lower my current tax liability rather than using the expenses to increase the cost basis of the house that I am flipping.

If long term capital gains tax for the sale of the investment house is 15%, doesn't it make more sense to worry more about finding deductions for my current income than to lower my capital gains tax liability later when I sell the rehab project? Or am I thinking about this all wrong?

[ColeenD3]

There is a difference between having a business that flips houses and having a home that you keep for investment purposes.

If you are in the business, then you deduct expenses. However, keep in mind what the IRS considers a business. Business

Investor or dealer?

The tax consequences of buying and selling real estate besides your personal residence largely hinge on whether the IRS considers you an investor or a dealer. Those terms can be a little confusing because most taxpayers eyeing a flip probably consider themselves investors while the IRS would characterize you as a dealer.

What’s the difference? There is no clear test for investing versus dealing—it’s based on facts and circumstances. The IRS looks at several factors, including motive and timing. Taxpayers who are in the business of flipping homes—especially multiple homes—are typically treated as dealers or real estate business owners. But those who hope to profit long-term are often regarded as investors.

Why does it matter? There are many tax consequences, but primarily, the focus is on the characterization of the property. Dealers, like other business owners, acquire inventory, not capital assets. When the flip is complete, the income is reportable just as any other business on a tax return. For non-corporate taxpayers, that means it shows up on a Schedule C, and self-employment taxes apply. But it also means that related costs are deductible as business expenses, even if it results in a loss.

If, however, a taxpayer buying and selling real estate is treated as an investor, the property—like that vacation home you bought years ago—will be considered a capital asset. The gain will be taxed as capital gain, which typically means more favorable rates— but if you lose money, the $3,000 limit on capital losses will apply. While investors are limited when it comes to expenses, you can deduct mortgage interest and real property taxes—subject to the usual rules, of course. That makes writing that check to the local authorities for your vacation home a little less painful.

Investor or Dealer