Have you decided that you want to be a real estate wholesaler but don’t know where to begin? Or, do you have some lingering reservations because you don’t know how to handle the money part? Well, read more and find out how to manage your taxes so that you don’t have to give the bulk of your profit to the government in taxes and penalty fees.
Let’s Review the Basics
Real estate wholesalers are people who sign contracts with property sellers and then assign those contracts to cash buyers. Real estate wholesalers sign contracts with sellers to control the property’s equity for a limited period while searching for people willing to buy it. Meanwhile, the property owner maintains physical possession of the property. The property’s equity is returned to the property owner if the real estate wholesaler fails to sell it.
In this case, you, the real estate wholesaler, sign contracts with the property sellers, then assign the contracts to the buyers and collect your payments for matchmaking the two parties. Now, you want to know who pays the tax on the property’s sale – the wholesaler, the owner, or the buyer?
Do You Pay Taxes on Wholesaling Real Estate?
You pay the taxes on any money you make as a real estate wholesaler. The buyer pays the taxes to the local and state government for acquiring the property. In this case, it’s like the property seller and buyer met and agreed to enter into a commercial transaction with one another. In this case, those two parties are responsible for paying the taxes they are liable for under law for the commercial transaction.
As a real estate wholesaler, you must pay taxes on any money you receive from the deal. Your money, or should we say profit, is the difference between the money you agreed to pay the seller for the property plus any money you spent on arranging the deal and the money the buyer agreed to pay for the property.
Wholesale Real Estate Tax Rate
The IRS tax code will govern the tax rate on your profit from selling wholesale real estate. Since real estate is considered an investment and asset, its taxation will fall under the long-term and short-term capital gains tax guidelines.
Long-term capital gains are profits earned from the sale of an investment or asset that has been held for more than a year. As a real estate wholesaler, your goal is to unload your wholesale property ASAP. You don’t want to hold onto the wholesale property for a year. Plus, it’s unlikely that sellers will agree to let you control the equity of their property for a year or more.
So, by default, you are more like to be paying the short-term capital gains tax. Fortunately for you, the short-term capital gains tax is much lower than the income tax rate, and you will not be required to pay any more taxes on it, unlike the taxes applied to wages and salaries.
Short-term capital gains taxes range from 10% to 37%, depending on your income tax bracket and marital status.
Real Estate Wholesaling Tax Deductions
Are you looking to offset the government bite into your profits? Tax deductions are the answer! So, which tax deductions can you use to keep the most money in your pocket?
Internal Revenue Service (IRS) Section 1031
IRS Section 1031 allows investors to reinvest their profits from a wholesale real estate transaction into another real estate investment without paying any tax on the money until the property that it was invested in is sold. The money must be reinvested into another real estate deal no later than two years after the date of sale of the property that generated it.
If you are 55 years old or older, you are eligible for a one-time real estate transaction tax exemption that can be used for a profit of up to $125,000. You should file IRS form 2119 if you want to use this deduction.
Standard Real Estate Deductions
There are standard tax deductions that can be applied to any profits from a real estate transaction. Those deductions include depreciation, home office expenses, travel expenses, and vehicle expenses. You should check with IRS and local tax agencies to determine what is required for you to qualify for the exemptions and what paperwork you must have to support your claims for the exemptions.
IRS Section 199A 20% Pass-Through Deduction
IRS Section 199A is an alternative to Section 1031. As a real estate wholesaler, your commercial activity may fall under this section. The guidelines are not clear, and case law (U.S. Supreme Court, Commissioner v. Groetzinger) on it is murky. So, your best bet is to contact a certified public accountant and/or a tax lawyer to help you properly plan your tax strategy and tell you if this deduction is available to you.
In Section 199A, there is a Safe Harbor under Procedure 2019-7. Safe Harbor allows you to get a 20% reduction in taxes on your net qualified business income (QBI). To qualify, your QBI must be connected to the conduct of a trade or business in the USA and be included in the categories of income that qualify for the deduction (see IRC Section 199A (c)(3)(B)).
Filing Taxes As A Real Estate Wholesaler
As a real estate wholesaler, you are strongly advised to engage the services of a tax lawyer and certified public accountant. While you may not be able to afford both, you should at least receive tax advice from one of them to avoid problems with the IRS.
Real estate wholesalers who operate as individuals, not corporations, are considered investors. You are selling real estate contracts for profit. You should withhold 80% of your taxes every quarter throughout the year.
You may also be required to make estimated tax payments on your capital gains from your real estate wholesale transactions. It is important that you make the proper tax payments on time to the IRS because your failure to do so may result in you being charged penalty fees.
Real Estate Wholesaling Tax Strategies
The best tax strategies for real estate wholesalers are taking advantage of the standard deductions available to investors and IRS Section 1031. There is also the age exemption for people 55 years and older, but it can only be used one time. IRS Section 199A 20% pass-through deduction may be a great strategy if it covers wholesale real estate transactions.