Foreclosure buy, rent & then sell

[KJ Judd]

Doctor is considering buying houses that are about to be foreclosed, then renting back to the previous owner with an option to purchase after 1 year for 20% above his purchase price. If previous owner doesn't buy back, he'll sell on the market.

If he flips enough houses, it's trade or business. Any guidance on how many houses a year to be considered trade or business?

Secondly, while he's renting the home, will this still be considered rental (i.e. no self employment taxes)?

He's considering either owning personally (although I suggested the LLC for liability purposes) or as a corporation.

[solomon]

Flipping normal connotes turning the property as quickly as possible. There is not fixed number to determine flipping. A Dealer, as a rule, in properties would have SE tax on the rents prior to sale.

However, I do not believe the case you describe fits either of those scenarios. Personally, I would treat this as an investment with rents on Sch E - especially because he will hold these properties well over one year.

[newbie]

My thoughts are if he is just purchasing to rent and resell - Schedule E income and Capital Gain at time of sale. He is purchasing as an investment.

[KJ Judd]

But his intent is to only hold about one year (not well over one year). He may have several of these properties in various stages at once.

The frequency and length of holding term is what concerns me. I realize this can be more of a gray area. From the first two responses, it sounds like I'm being too conservative here. (Keep in mind this doctor is well over the Social Security limit. So we may be better with the trade or business route so he can deduct any rental losses.)

[solomon]

If his intent is to make 20% and depending what part of the country in which he will be trying to sell the properties, he may well be holding them well over one year. We do not know all of the details.

For example, will he carry the note for a tenant that was about to go into foreclosure? If not, there might be a good chance the person will not be credit worthy even if the person wanted to exercise the option to buy back the home. If he has to put it on the market, will he hold out for his 20% or sell it for what he can get? Is he getting such a deal on the foreclosure that his 20% will be a slam dunk in one year?

He must rent at fair market value or he will have no deductions (rent below fmr is considered personal use) other than interest and taxes on Sch A - so he should not be thinking a loss on rents. If there is a loss and his MAGI is too high to utilize it, upon sale the suspended loss will be free for use.

[newbie]

Again, just off the top of my head w/out research, the doctor is buying, renting with hopes of selling at a gain, a capital asset whether it be long term or short term.

Unless these homes require material participation for some reason before an actual sale can be made I don't see a SE issue and if he sells at a gain after holding onto the house for > a year the advantage of capital gain rates.

[KJ Judd]

He will personally borrow money from the bank to purchase the property about to be foreclosed upon. The previous owner will have an option to purchase the property at 20% above his purchase price. (The example I was given was $115k purchase price, approx. $138k option sale price to previous owner. Assessed value $145-150k, homes in area selling for $150-160k.) So there is incentive for former owner to repurchase home.

These properties would be screened. He's looking for people who temporarily fell on hard times - illness, job loss. Give them a year to clean up their credit and repurchase the home. They already have some equity in the property. The 20% price is less than FMV so they'd have incentive to purchase. Sometimes a family member may purchase the home at the end of one year. I guess there are some rules that preclude a family member from purchasing during foreclosure.

The FMV rent is a good point. I missed that in concentrating on the other issues. His intent is to rent a couple hundred dollars above what his loan payment would be. He's attempting to get a win-win situation.

And yes, his AGI is such that any rental losses would be suspended. He anticipates minimal fix-up or repair costs during ownership.

[solomon]

I still see it as an investment rather than rising to the level of a trade or business. In my mind it is most crucial he can substantiate a rent at a fair market rental rate. In the Jackson case, the Tax Court accepted a realtor's estimate - which in this case was above the rent being charged and thus only interest and taxes were permitted as a deduction - no other expenses.

[Kram BergGold]

Clarification

One poster said put it on Schedule C so he can deduct the losses. I disagree. If you decide this is a trade or business and go Schedule C he would have to materially participate in order to claim losses. From th eorigianl post I doubt the doctor plans to spend much time looking after these properties. My feeling is the decision as to whetehr this is a business venture (Schedule C and no cap gain) or an investment (Schedule E and cap gain) should be decided by how much time he spends on the activitity. Does his involvement rise to teh level of running a business or is it more like buying stocks and bonds and occaisionally checking on them. My guess is it si the latter.

[Matt Sova]

Residential rentals

Residential rentals go on Schedule E. If and when they are sold he will have cap gains not a Schedule C situation. It does not matter how many he does or how long he holds them.

The last part of your question said you are suggesting an LLC or a Corp. NEVER, EVER put appreciating property into a corp, not even an S-Corp. Put each rental into it's own LLC.

[Snaggletoof]

1099s

If you declare a house "rental" and thus an investment versus a business as Sova has suggested:

...I don't see anyone getting off the hook for having to issue 1099s, if a contractor did repair or remodeling to a house and was paid more than $600.

[KJ Judd]

Thanks everyone for the great thoughts. Some of you raised issues I hadn't even thought of yet. That's why I love this board! I'll mention these next time I speak with him. He'll be glad to know it can be capital gain. (Because I agree, his involvement with the properties will be minimal.)

[abby]

FMV rent

One point - there may be many legitimate business reasons to rent to someone below FMV and that does not automatically translate to personal use.

If you are not renting to a related party, then I would imagine that there is a business reason to rent below the market.

[KJ Judd]

The intent would be to rent for enough to cover mortgage payment. If the renters are intending to repurchase the home, they have incentive to take care of it and treat it well, perhaps even do small repairs.