I get a question from time to time, in various forms, about write-offs on investment real estate.
For people just getting into the game, the answer is yes, you are in business, and you do get to write off the ordinary and necessary expenses of a business when reporting income to our favorite Uncle.
The full cost of your general and subcontracted labor, of course.
The technical reality of actually writing off the purchase of the structure you’re improving.
This occurs through the simple process of deducting all the costs of acquisition, what we call the “cost basis,” to arrive at the gain on the sale.
Job materials: lumber, wallboard, fixtures, all of it.
Insurance, interest on the financing (assuming you used either a bank or hard money), property tax, all increase the size of your operating expense total, thus reducing net income.
Unlike rental real estate, where you file Schedule E with your Form 1040, you are actually in business.
In fact, you should have already created a limited liability company (LLC) for your business.
And you should consider operating it as an S Corporation as well, because this most certainly is self-employment income.
(More on that subject in past, and future, blog articles and postings).
So it comes to pass, from time to time, that someone realizing all of the small tax advantages asks this next question:
Can I deduct my own labor when flipping a house?
You may even make the strong-sounding argument that you know exactly how much your labor is valued in quantifiable time, and I’m here to tell you that people have tried to persuade me to do it.
But you just can’t.
More exactly, you can, but you don’t want to get caught at it.
It’s not legal according to the IRS Code.
I’ll give you the direct quote from IRS Publication 535, Business Expenses:
If you provide services to pay a business expense, the amount you can deduct is limited to your out-of-pocket costs. You cannot deduct the cost of your own labor.
I suppose Uncle Sugar (what I call the Ultimate Government Piggybank) feels there is too much room for abuse of the privilege, and that people can just make up a number and thereby cheat them out of that little bit of extra pork.
Piggybank – pork – I detect a theme here.
But seriously, folks…
I suppose the Socratic argument would be that there is too much subjectivity in the self-valuation of one’s time. I’m betting that’s what Joe Congressman would tell you in one way or another, if you pushed hard enough.
Let me ease your worried minds a bit with a mathematical certainty about write-offs.
I think it’ll help ease the pain of the denial of the self-labor write-off. Okay?
I’ve shared this before, it bears repeating, I will certainly share this again.
Throwing in your own labor will give you back 100% of reduced cost of hiring someone else, and that cost would have only mathematically reduced a percentage of the expense anyway.
That’s right.
Let’s say you pay a crew $5,000 to do a demo and throw up wallboard.
When you and your spouse (if you have one) file the following year you’ll be reducing your gross house flipping income by that $5,000.
Not the tax itself. The gross income.
If you pay a fairly typical 15% effective tax rate, that means you’re only realizing $750 in tax savings.
So, take heart! It’s really not all that bad.
I would also add that you may, in the long run, find the logistical cost in time and stress of hiring an expert instead of spending your own precious money-making time on labor yourself to be the wiser course.
It’s still a great way to increase your wealth, and I know a lot of people creating wealth for themselves and beautiful homes for others in this business.
Happy flipping, everyone!