Wholesale Real Estate Taxes: Learn Exactly How To File In 2024Dec 28, 2023
How does your wholesaling business change the method and determining factors for paying income taxes?
To help answer these and other questions, we will cover everything you need to know about wholesale real estate taxes in this article:
- What Are Wholesaling Real Estate Taxes?
- Do You Pay Taxes On Wholesaling Real Estate?
- Tax Forms For Real Estate Wholesalers
- When Are Wholesale Real Estate Taxes Due?
- Understanding Taxes On Real Estate Wholesaling
- How Can I Avoid Paying Taxes As A Wholesaler?
- How To File Taxes As A Real Estate Wholesaler?
- Final Thoughts On Wholesale Real Estate Taxes
What Are Wholesale Real Estate Taxes?
Among the many elements to consider when embarking on the wholesale real estate business, be aware of tax implications. Not only are there federal taxes, but you may need to consider state, local, or other wholesaling real estate taxes.
Wholesale real estate appeals to many as a lucrative trade since the profits on real estate transactions can be several thousand dollars per transaction.
With the benefits come the complexities of the wholesaling real estate business. There are financial nuances to note with wholesaling real estate taxes.
Regardless of how a person or a business generates earned or passive income, the IRS requires filing a tax return in most cases.
Do You Pay Taxes On Wholesaling Real Estate?
There are specific taxes related to the sale that will be the responsibility of the seller and the buyer. These include all relevant state, local, or other taxes.
As the middleman in the transaction, the wholesaler doesn’t typically take ownership of the property and aims to move the transaction from motivated sellers to buyers as quickly as possible. This avoids expenses associated with asset appreciation and prevents taxes related to holding the real estate property.
The wholesaler will pay taxes on money earned through the sale, usually in their assignment fee. As the wholesaler collects a professional fee for connecting the seller and end buyer, that amount is often considered as taxable income.
Tax Forms For Real Estate Wholesalers
When it comes to declaring your earnings from real estate wholesaling on your tax returns, the process varies based on your chosen business structure.
Understanding the different structures and their corresponding tax requirements is crucial.
Common Business Structures for Wholesalers
- Sole Proprietorship: This is a straightforward, unincorporated business where your income is reported directly on your personal tax returns.
- Limited Liability Company (LLC): This structure offers limited personal liability and is treated as a separate legal entity.
- Partnership: In this setup, the business is owned by multiple individuals, sharing profits and responsibilities.
- S-Corporation: A specific tax classification that can provide certain tax benefits to shareholders.
Essential Tax Forms For Wholesalers
- Schedule C (Form 1040): Used by sole proprietors and single-member LLCs to detail business income and expenses on personal tax returns.
- Form 1065: Necessary for partnerships or multi-member LLCs to report business earnings and expenditures.
- Form 1120-S: Employed by S-Corporations to document business income and expenses.
- Form 1099: Required for any wholesaler employing subcontractors, to report payments to them exceeding $600. It is common for attorneys to issue a 1099 for each wholesaling transaction outlining your earnings. However, you're responsible for reporting this income even if you don't receive a 1099.
- W-2 Form: Utilized by S-Corporations or corporations with employees, including the business owner, to report wages and benefits.
Always seek advice from a qualified tax advisor to ensure accurate reporting of your wholesaling income.
Remember, the right tax forms and reporting methods depend on your specific business structure, making it essential to understand these details for accurate tax filing in the realm of wholesale real estate.
Based on answers to questions about filing status, income tax withheld, and gross income, most wholesalers will determine that they do have a filing requirement. Let’s examine this in more depth.
What Is Gross Income?
According to the IRS’s 2021 version of Publication 17, gross income “includes all income you receive in the form of money, goods, property, and services that is not exempt from tax.”
Gross income also includes income from outside the United States (even if you can exclude all or part of it). When you are wholesaling real estate property in another country, the IRS will want to know about the income earned from these transactions as well.
In some cases, wholesalers earn their income as W-2 employees working for someone else. But there are other ways to make money in the real estate business. For example, if your paycheck comes as a sole proprietor, an independent contractor, a member of a partnership, or as a business structured in another way.
Regardless of how the business is structured, it’s essential to understand the legal ramifications of wholesaling real estate taxes. That is only true if you wish to avoid trouble with the IRS.
Costly tax planning mistakes that result in IRS audits can not only your pride but also your wallet in terms of late fees or penalties that can dramatically decrease your bottom line.
Avoiding tax trouble starts with consulting a tax professional who understands the intricacies of wholesaling business-related taxes at the federal, state, and local levels.
Especially if you are conducting business in more than one state, be sure to consult both a tax expert and a legal expert instead of trying to figure it out on your own.
Capital Gains Tax
In most cases, selling property is categorized as real estate investing or investments by the IRS. As such, they may fall under short-term or long-term “capital gains” tax guidelines depending on how long the seller held them.
The gain on the sale of the asset is taxed. Profits from real estate sales are taxable depending on how long the investment was held before the sale.
While short-term capital gains are typically lower than most individual income tax rates, they usually apply to circumstances when a wholesaler takes possession of the naturally distressed property. Because most wholesale transactions do not involve the wholesaler taking possession of the property, this tax is not usually applicable to the wholesaler.
The Wholesaler’s Assignment
With wholesaling real estate taxes, the typical situation involves an “assignment of contract” where the wholesaler doesn’t own the property. Instead, real estate wholesalers assign property via contract between the property/homeowner and end buyer, usually cash real estate investors.
This end buyer assumes the right to purchase the named property for a fee. This wholesaler receives the assignment fee as payment.
In this case, for wholesale deals, asset appreciation isn’t taxed in the same fashion as a traditional real estate sale. Instead, the assignment fee is considered income.
Knowing The Wholesale Real Estate Tax Codes
There are unique differences in tax codes for real estate transactions, business transactions, and capital gains tax transactions that will manifest at tax time. Therefore, for questions on wholesaling real estate taxes, it’s critical to work with a tax expert to ensure wholesalers accurately report income about your wholesale real estate business.
In many cases, business deductions, credits, and other exemptions may offset capital gains. Still, if not done correctly, taxes may engulf a large chunk of profit gained through wholesaling real estate.
Aside from legal tax exemptions and other tax loopholes, real estate transactions should be taxed in line with federal, state, and local laws. Wholesalers must understand how the real estate sale profits found in one’s residence are taxed differently than business revenue or capital gains.
When Are Wholesale Real Estate Taxes Due?
Here are the key due dates for estimated tax payments:
- April 15th: This date marks the first quarter's estimated tax payment deadline.
- June 15th: The second quarter's payment is due by this date.
- September 15th: This is the deadline for the third quarter's estimated tax payment.
- January 15th of the Following Year: The final quarter's tax payment should be made by this date.
As a real estate wholesaler, your earnings are classified as self-employment income by the IRS. This classification necessitates a proactive approach to tax payments, typically through estimated tax payments made quarterly.
To avoid potential penalties from the IRS for underpayment, it's vital to consistently set aside funds for these tax obligations. IRS Publication 505 can be a useful resource in calculating the amount due each quarter.
It's important to note that if these dates fall on a weekend or a public holiday, the deadline is typically extended to the next business day. Planning your finances with these dates in mind ensures timely payments and helps avoid unnecessary penalties from the IRS.
Real Estate Wholesaling Tax Deductions
When looking to minimize wholesaling real estate taxes, wholesalers should think about some of the most common allowable expenses necessary for a successful wholesale real estate business.
- Vehicle expenses
- Contract labor
- Legal and professional services
- Office expenses
- Rent or lease
- Travel, meals, and entertainment
- Other expenses (website, bank fees, cell phone, professional dues, memberships, etc.)
Vehicle expenses or “driving for dollars” can eat a large chunk of a wholesaler’s budget. Consider the slight decrease in the 2021 Mileage Rates for Business. Wholesalers can deduct 56 cents per mile for business miles driven this year.
Also, marketing and advertising tax deductions can be huge for wholesalers. Whether you utilize a professional service or take out ads on social media, wholesalers often need help finding properties.
Tax Deductions For Wholesaling To Consider
Since they are “borrowing” your money interest-free, an equally important goal is never to have the IRS owe you money either.
Instead, there are perfectly legal tax strategies to help reduce or eliminate wholesaling real estate taxes.
Real estate wholesalers should consult a tax professional as well as a legal expert to ensure their ability to retain as much hard-earned money as possible and avoid any unfortunate IRS encounters.
Because most wholesalers conduct their transactions under a form of business, they commonly itemize tax deductions instead of taking the lower standard deduction. This practice allows wholesalers to reduce tax liability by decreasing their taxable income.
Reducing or eliminating taxes can also be done by finding exemptions the wholesaler may be eligible for. Because it is impossible to outline every tax planning consideration or loophole that may apply to each wholesaler, the need to consult a tax professional and legal expert cannot be overstated.
For wholesaling real estate taxes, the responsibility is on the wholesaler to understand tax liability and develop a personal investment strategy that can help minimize tax liability.
According to Connie King, who worked for the IRS for 23 years, the U.S. tax code requires wholesalers to follow the same laws as other business owners.
For example, wholesalers need to prepare quarterly tax payments by withholding 80% of their taxes every four months. Because the United States has a “pay as you go” tax system, unlike W-2 earners who have their taxes withheld on earned income throughout the year, wholesalers are responsible for ensuring the IRS knows how much money they earn.
Be sure to withhold the appropriate amounts to cover quarterly estimated tax payments throughout the year. Even if you anticipate a refund, failure to pay a wholesaler’s estimated tax payments throughout the year may result in late fees and penalties.
Understanding Taxes On Real Estate Wholesaling & How They Work
Because wholesaling generates taxable income, understand how to conduct your real estate transactions and structure your business for tax purposes.
Like most taxpayers, wholesalers strive to keep as much of their earned income in their pockets as possible. Working with your tax professional can help you determine the costs, liabilities, obligations, and tax benefits associated with each type of business structure.
In most cases, wholesaling real estate taxes can be figured in this fashion:
- Add your income from all sources
- Subtract your deductible expenses from your business
- Pay tax on the amount remaining after subtracting #2 from #1
Consider the following example: You negotiate $200,000 for a property. However, you have an investor willing to pay $250,000 for the same property.
The difference is your assignment fee. This is likely going to be considered as taxable income. Where and how you report that income depends on several variables.
This will be business income if you’re a single-member LLC or sole proprietor. You’ll pay tax on net profits after reducing expenses on Schedule C of your tax return.
When structured and taxed as a partnership, S Corp, or C Corp, you’ll find differences in reporting, and this type of income won’t appear in the same way on the more familiar Form 1040.
And, if you decide to buy and sell properties, taking ownership through double closings, you will face different tax implications than your peers who choose to assign contracts. Knowing these differences can help you steer clear of tricky tax topics when it comes time to file your taxes.
When assigning contracts, the wholesaler cashes wholesale checks, collects assignment fees, and behaves as an independent contractor in a 1099 situation. This is different from a W-2, where an employer ensures the taxes are taken out based on the W-9 filled out by the employee.
Since wholesalers do not usually take ownership of the property, they are not commonly on the title. If they are, the goal is to move the property out of their hands as quickly as possible. Because of this, most of the time, as business owners, wholesalers don’t pay property taxes, like the homeowner, property owner, or real estate investor.
Conversely, in the instance where a wholesaler engages in a double closing, there may be different tax considerations in terms of the city, state, local, or other taxes paid at closing. So, again, consulting with a tax expert, title company, and legal expert will help you avoid costly mistakes at tax time.
How Can I Avoid Paying Taxes As A Wholesaler?
As law-abiding citizens always want to ensure compliance with the tax code, there are legal ways to reduce tax liability while minimizing scrutiny by the IRS.
For example, while income earned through becoming a professional at wholesaling real estate is subject to all applicable taxes, wholesalers can maximize their deductions and offset taxes assessed on all their sources of revenue.
While not uncommon to assume you’ll be subject to higher tax rates in any realm of real estate business, wholesalers can legally avoid the self-employment tax by being taxed as an S-Corp.
According to some CPAs, ineffective strategies could land wholesalers with tax rates greater than 50% of their ordinary income. On the other hand, structuring as an S-Corp may prove beneficial.
As an example:
Wholesaler A is structured as a Sole Proprietorship or LLC and reports $100,000 income on Schedule C. Without factoring in the marginal tax rate or state taxes, Wholesaler A will pay $15,300 for the 15.3% self-employment taxes.
Wholesaler B structures as an S-Corp for taxation purposes. Paying herself $50,000 as a W2 wage, the remaining $50,000 is a cash dividend. In this instance, the $50,000 cash dividend is not subject to the 15.3% tax, and Wholesaler B experiences a tax savings of $7,650.
Wholesalers may also wish to consider 20% pass-through deductions, bonus depreciation on multifamily properties, cost segregation studies, or other qualified business income deductions that are legitimate methods for reducing wholesaling real estate taxes.
How To File Taxes As A Real Estate Wholesaler
As mentioned, wise wholesalers solicit the support of a tax professional as well as a legal professional to ensure compliance with federal, state, and local tax codes.
A tax accountant or Certified Public Accountant (CPA) is necessary for anyone who wants to relieve themselves of the heavy burden related to tax work. Any time a wholesaler makes a business decision that might impact their taxes, it’s always wise to seek the advice of an expert.
While it may seem like a burden to have the extra expense, it will ultimately save time, stress, and money in the long run as you avoid trouble with the IRS.
At the same time, relying on your accountant should not replace a wholesaler’s need to have a basic understanding of specific tax requirements related to your wholesale real estate business.
Any smart business owner must understand accounting and stay on top of their books. Otherwise, how would you know if you're running a profitable enterprise?
Strategic Tax Management For Real Estate Wholesalers
As you develop your real estate wholesaling business, adept handling of your tax obligations is key to avoiding complications with the IRS. Engaging a tax professional can be a smart move, offering guidance tailored to your business's growth. Here are some expert tax strategies they might suggest:
1. Diligent Expense Tracking
Maintain accurate records of all business-related expenses, regardless of their tax-deductible status. This could be through traditional paper records or a digital system, with the main goal being easy accessibility and organization. The IRS advises keeping financial records for a minimum of three years.
2. Allocating Funds for Taxes Regularly
Rather than scrambling for funds annually or quarterly, it's prudent to allocate a portion of your earnings for taxes after each successful deal. The amount to set aside varies based on factors like your tax bracket, local and state tax rates, and your business structure. Consulting with an accountant or CPA can help determine the right percentage for your tax reserves.
3. Understanding Local and State Tax Obligations
Awareness of your specific state, county, and city tax rates is essential for accurate financial planning. These rates are typically available on government websites and are crucial for determining how much to reserve for taxes.
4. Tax-Efficient Business Structuring
The structure of your business significantly influences your tax liabilities. For instance, income reported under structures like sole proprietorships, LLCs, or partnerships is subject to self-employment tax (15.3%) in addition to regular income taxes.
In contrast, as the proprietor of an S-Corporation, your tax situation shifts notably. In this scenario, you're recognized as both the owner and an employee. This distinction is crucial for tax purposes, as it means self-employment taxes are only levied on the salary you pay yourself, not on the entire business profit.
Let's go over an example.
If your wholesaling business generates a profit of $60,000, and you opt to take a salary of $30,000, the self-employment tax, calculated at 15.3%, would apply only to your salary, amounting to approximately $4,590.
As a sole proprietor, the same $60,000 profit would incur a self-employment tax of around $9,180.
This structure can yield significant savings, in this case, potentially around $4,590. However, it's essential to remember that the IRS requires your salary to be reasonable for the work you do, limiting how much of your profit can be classified as a distribution to optimize tax benefits.
Adopting these tax strategies can lead to more efficient tax management in your real estate wholesaling business, ensuring compliance and potentially maximizing your profits. Always consult a tax professional for personalized advice tailored to your specific situation.
Final Thoughts On Wholesale Real Estate Taxes
Because it’s common to earn a substantial amount of money in a relatively short amount of time, many are attracted to wholesaling real estate because of the seemingly limitless potential to earn income in the real estate industry.
As such, concerning wholesale real estate taxes, it’s important to remember that taxes are a given whenever income is involved. Further, according to IRS Publication 525, “In most cases, an amount included in your income is taxable unless it is specifically exempted by law.”
Regardless of how a wholesaler structures the business, there are myriads of elements to consider when looking for legitimate opportunities to minimize your wholesaling real estate taxes.