Wholesaling might be the most commonly suggested way for people to get started in real estate. This was always interesting to me because A. Wholesaling is freaking hard. B. You typically never actually own any real estate.
For those who don’t know wholesaling is a term generally used to explain a situation where someone is able to negotiate a great price for a property. They sign a contract to buy the property for that great price. Included in that contract is the wording “and or assigns”. This means that either the person signing the contract, or someone he/she assigns the contract to, has rights to uphold the purchase end of the contract. This then allows that person to sell the contract to an end buyer who will either flip or keep the property as a rental. It’s kind of like a finders fee- but one that’s determined by the finder and how good of a deal they can negotiate.
Example: If a person is able to negotiate a price of $50,000 on a property that someone would be willing to pay $70,000 for- they’ve essentially set their “finder's fee” at $20,000 for that property. There are many ways to structure the deal- but that’s the nuts and bolts of it.
Here’s why I say wholesaling is hard: You really need to know your stuff. You need to be very familiar with local pricing, repair costs, after repair values, ect….to ensure that what you’re putting under contract is actually a good deal. It’s easy to get a bad reputation quickly if you’re sending investors houses that aren’t really good deals.
So that’s my run-down on wholesaling- Now you’ve either gotten a crash course...or you’ve skipped that whole intro because you’re already a wholesaling-pro…..let’s move onto the tax side of things.
If you’re skipped that intro to get to the tax part I’m assuming you did what many couldn’t- made money wholesaling properties.
We both know it takes a ton of time, research, follow-up, and drive to be successful as a wholesaler. You’ve put in the work, now you want to reap the reward: Let's talk about how to keep as much of that reward as possible in your pocket.
Wholesaling is considered a business in the eyes of the IRS. You might associate yourself as being a real estate investor, unfortunately they disagree. Which ….means less of the un-fairly great tax benefits. BUT! Don’t lose hope. There’s still some great deductions you can take advantage of as a wholesaler.
You are typically going to be reporting your business income and expenses on Schedule C of your 1040. This is true if you are operating as a sole proprietor, or if you’re operating under a single member LLC.
There might be a point where it could make sense to elect to have your LLC moved off of your 1040. This would be done by making an election to have it taxed as an S corporation which would move it to a form 1120S (most common), adding a partner and having it move to a form 1065, or a few other very rare options as well.
Now, it’s important to know early on that the answer to almost any tax question is “it depends”. Tax plans are like snowflakes- no two are the same. So when it comes to answering the question of “When should I move my wholesaling business off my 1040?” the answer will be “it depends”. I will say that typically, I start looking at this option once people are anticipating making upwards of $20,000 for the year. At this point the extra expense and hassle of a separate entity is outweighed by the tax savings.
((Stand by for a follow up blog on what and why I might recommend moving your Wholesaling or Flipping business to a form 1120S. ))
Typically, allowable expenses include anything that is necessary and required for your business.
Below is the section of schedule C that lists standard expenses.
Advertising expense is obviously a big one for wholesalers. The most common way wholesalers find properties they can get for a deal is by marketing to properties that are not currently listed for sale. If you’re the only person who knows buying a house is an option, you’ve got a much better chance of closing that dea. No competition. What type of advertising expenses qualify? Anything direct used to build interest and market your business: Billboards, signs, list source lists, labels, Facebook boosts.
Auto expense is another great deduction. It's important to note that with vehicle expense you can take either mileage or actual expenses- and you need to stick with the chosen method. It's almost always better to utilize mileage expense. I recommend using an app like mileIQ for this. For 2017 miles are worth 53.5 cents each. This means that if you're driving 100 miles a week driving for dollars you will end up with 5,200 business miles for the year which equates to a business expense of $2,782.
If you decide to go with actual automotive expenses- you need to keep in mind that this will be limited by the portion of your driving that is business vs. personal. If you spend $10,000 a year on car maintenance/lease payments/ gas/ ect….but only 10% of your driving is for business purposes, then only $1,000 is deductible.
Other Expenses :
Now here is the fun part. “Other expenses”. It's like a secret level in a video game. It’s always existed, but you had to know where to look for it.
Other expenses for a wholesaler may include the following:
Telephone expense (50-70% if you're using your personal cell phone)
Web domain and hosting
Parking & tolls
Safe Deposit box
Online Services (digital fax, telephone)
Dues and Subscriptions (REIA membership)
Meals and Entertainment (50% deductible)
Home office deduction ( more on this soon)
I really like wholesaling as a business area and you should too. It’s a great way to build capital without the time consumption involved with flipping houses. When it comes to taxes you are ultimately operating like a business- and the name of the game is going to be how much of your everyday expenses can legally be shifted to business expenses.
Do you already pay for a vehicle? Do you already pay a mortgage? How about for a cell phone? How much money are you spending ALREADY that we can now shift to being a tax deduction in addition to a cash out flow?