Capital Gains and Losses

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I have a client who is in a house flipping business. In 2016…

I have a client who...
I have a client who is in a house flipping business. In 2016 he bought property for 700K and spent 300K on renovation. In 2017 he spent another 200K on renovation and sold the property for 1,400,000 dollars (profiting) 200K. However, because we deducted 300K in 2016, the profit in 2017 (rather than 200K), it shows 500K. He has no problem here, because he always has 3-4 properties and for 2017 his actual income is -50K (because of the expenses from other properties). Each property is under separate LLC and the issues for 2017 is the following: His income is -50K (for all 4 combined LLCS) and his actual net profit from the sale is 200K (for that one LLC and he is supposed to pay capital gain for 200K). However, the system shows that he will end up paying capital gain on 500K (because we are closing that LLC. Anytime we are done with transactions for one house, we close the llc and with new property purchase we open a new llc).
I dont mind to show in income for 500K, but does he have to pay capital gain on 500K????
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Answered in 11 minutes by:
3/11/2018
Carter McBride
Carter McBride, Professor
Category: Capital Gains and Losses
Satisfied Customers: 1,308
Experience: Adjunct Professor
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Hey! I'm Carter, I'm a CPA and can help you out with this.

First off, these are not capital gains. This is ordinary income. He's in a business, so the homes are considered inventory. Technically, all of the renovation costs need to be capitalized under 263A Unicap rules.

So in 2016, you'd have beginning inventory of $0, purchases of $1,000,000, then ending inventory of $1,000,000, so your COGS is $0. In 2017, your beginning inventory is $1,000,000 plus purchases of $200,000, and ending inventory of $0, so your COGS is $1,200,000.

When you have the sale then in 2017, you'd have $1,500,000 of gross receipts less the $1,200,000 of COGS, so an ordinary gain of $300,000.

Your best bet would be to amend the prior year to properly account for the inventory, which will reduce the 2017 income.

Let me know if you need anything else If not, please leave a rating. Thanks!

Carter McBride
Carter McBride, Professor
Category: Capital Gains and Losses
Satisfied Customers: 1,308
Experience: Adjunct Professor
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