How can you scrap an existing building, build four condos on the site, and not be taxed at ordinary income tax rates upon sale?
Let’s say you have owned a beach property for over 30 years. It is now valued at $2 million and your cost basis is $200,000. You’d like to demo the building, build four condos on the property and sell them.
The cost to build the project is $600,000 for each condo or $2,400,000. You can sell each condo for $1,200,000, for a total value of $4,800,000. The profit on the project is ($4,800,000 – $200,000 – $2,400,000) = $2,200,000.
If you do this, the profit will be taxed as ordinary income (roughly a 40% marginal rate) since you are now the developer of the project.
LSL CPAs would recommend setting up a new S Corporation to sell the existing land and building on a note to the S corporation for $2,000,000.
This will give you capital gain on the land of $1,800,000, taxed at a 20% marginal rate. The corporation will have basis in the land of $2,000,000 and future construction costs of $2,400,000.
The total cost of the project is $4,400,000. When the corporation sells the condos they have ordinary income of $400,000. This plan gives you capital gain of $1,800,000 and ordinary income of $400,000.
This saves you ($1,800,000 x 20%) = 360,000 in federal income tax for the difference between the ordinary and capital gain rates on the sale of the land.
For more real estate strategies call LSL CPAs at 714.569.1000 or at [email protected].
Written by: Ronald D. Stumpf, CPA
