You may think that since I’ve been flipping houses for almost a decade that I’ve got this down & free from mistakes. While I feel like I do “have this down,” I still make mistakes. In fact, the biggest financial house flipping mistake I’ve made since I started recently cost me a lot of money. You may remember this post where I talk about the various ways you can fund a flip, and you may remember this post where I talk about the only way to avoid capital gains tax. However, on Flip 5, I made a monumental error that goes against everything I’ve preached!
The Biggest Financial House Flipping Mistake I’ve Made
The mistake: I purchased a primary residence in the name of my multi-member LLC. And if you don’t know why this is such a monumental mistake, I’m explaining why and how you can avoid it!
I Lost My Capital Gains Exclusion
Since Flip 5 has functioned as my primary residence, it should qualify for capital gains exclusion. However, in legal tax terms, an LLC is an entity, not a person. Entities are not eligible for benefits designated for individuals.
So for Flip 5, since it’s held in the name of the LLC, I will pay capital gains on the profits when it sells. At today’s market value, that tax bill is anywhere from $8,000-$10,000.
I Created A Tax Bill For The Other LLC Members
Since the house was purchased with a multi-member LLC, the profits are distributed according to how the LLC is set up. It’s not possible to have 100% of the proceeds be assigned to me. So for the other two members in the LLC, it will show as taxable income- even though they haven’t contributed in any way financially to the project. Since it’s not fair for them to pay a tax bill they aren’t responsible for, I will have to pay the taxes on those profits…and unfortunately they’re at a higher tax bracket (which means more taxes).
I Had To Hire A Tax Attorney
The complexity of this situation baffled just about everyone. I eventually had to hire a seasoned tax attorney to sort out the mess. It took several conference calls, emails, & curse words to figure out I really only had 2 solutions: pay for a refinance and deed the property to myself and start the 2 year capital gains clock (about a $2,500 expense) OR pay the capital gains when I sell the property. The benefit of the tax attorney is that we analyzed every possible scenario & solution, and I received honest feedback like “That would probably get you audited!” So after months of discussions, we settled on those two possible solutions as the safest. But as with everything in this mistake, this was another expense. I spent almost $1,000 in attorney fees.
Lessons Learned From This Financial House Flipping Mistake
Anytime I make a mistake and there are financial consequences, I assure you I don’t make that same mistake again. It stings throwing money down the drain! A few lessons I’ve learned through this long & expensive process:
- Never, ever buy a personal residence in the name of a multi-member LLC
- Consult a tax attorney BEFORE you do anything unusual with your LLC
- I used an equity line commercial loan to purchase Flip 5– which is in the name of the multi-member LLC. This added to the complexity of the situation. I had to have a conference meeting with the President of the bank, commercial lenders, and the members of the LLC.
- In summary: don’t mix business with pleasure. The LLC & equity line our LLC has is a major asset in my house flipping business, but it’s a nightmare when it comes to personal residences.