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In this episode, Brandon Hall & Thomas Castelli discuss key strategies and tips property flippers and developers can consider to minimize taxes on their profits!
In order to counter the dealer status and the various taxes that come along with it, you have to mitigate your exposure to the self-employment tax and reduce your exposure to the ordinary income tax. There are two primary strategies that you can use to mitigate the self-employment tax - the real estate professional status and S corporations.
Real Estate Professional Status
By being a real estate professional, the losses from your rental properties become non-passive. The income from your flips are ordinary, but non-passive in nature. So when you buy some rental properties and do cost segregation studies to them, it's going to generate non-passive losses that can offset your flips.
To qualify as real estate professional, you have to spend 750 hours and more than anyone else in a real property trade or business. So if you're flipping property or developing property, and you are in the real property development or redevelopment business which are two of the 11 Real Property businesses that you can qualify as a real estate professional status for, then you can be a real estate professional as a flipper or a builder.
We have a whole series on the real estate professional status and we highly recommend that you go check it out.
What the S corporation does is that it allows you to pay yourself a reasonable salary. And on that reasonable salary, you're going to be subject to that 15.3% self-employment tax on that salary only.
So whenever you run an S corp, you have to pay yourself a reasonable salary. The IRS wants you to pay yourself a salary equal to your net profit.
You can't pay yourself a salary of $0 because that's not reasonable. The salary is the portion of your net profits from an S corporation that is subject to that 15.3% tax.
To come up with a reasonable salary, you have to go to the Bureau of Labor Statistics, do actual research on the activities that you're performing in your geographic location and come up with a weighted hourly rate. Then we multiply that weighted hourly rate by how much time you spend in your business every year.
That's going to give you a salary that is easy to substantiate and defend when you're audited.