June 13, 2005 — Jan in Alabama recently went shopping for a condo and found they had already been sold to "flippers" — before they were built. She wants to know just how that works — and if she ought to give it a try. Gregory in South Carolina, meanwhile, is going into business as a consultant. He wants to know whether he has to pay taxes on the "per diem" portion of his new paycheck.
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A FLIP ANSWER
… My questions are: What exactly is flipping [real estate]? How can you do it without losing your shirt (when you don't have much of a shirt to begin with)? and Can you make money do it, whether it is pre-construction or existing — with little or no money down?
-- Jan H. – Birmingham, Ala.
A: Flipping is just a term for speculative real estate investing — when the buyer has no intention of occupying (or even renting) the property. The idea is to buy at a price that gives you the opportunity to profit by holding that property for only a short period of time.
Flipping has become popular in overheated housing markets lately because prices are rising so quickly. In fact, strong buying by flippers is now a major cause of overheating in many markets. Yes, some people are making lots of money. Most flippers use a lot of leverage (little or no money down, interest only loans, etc.) to get even more bang for their buck. If you already own a home, and you’re willing to pledge your equity in that property against a new loan, it’s not hard to borrow with no money down. (That "easy money" is another reason housing markets are overheating.)
But this is a very risky form of real estate investment for beginners. A lot of things can go wrong. "Pre-construction" sales happen when a builder wants to raise cash and sells contracts for planned units, sometimes at below-market prices, usually to professional investors, before anything has been built. Many developers operate with very tight cash flows. If that cash flow gets too tight and the development doesn’t get built, you’re stuck with a loan on a condo that doesn’t exist.
Flipping existing properties can also be risky. It’s pretty difficult these days to find a property that’s “under priced.” With rates low and demand still strong, most sellers are asking for — and getting — top dollar. That means you’ll have to hold the property for awhile to see any serious price rise (your profit). While you’re holding that property (with no rental income), you’re gambling that your eventual profit will exceed the carrying costs you’ll be paying out until you sell. Those costs are mostly just mortgage interest and taxes, but you’ll have to spend some money on upkeep or the property won’t list very well when you decide to sell it.
The main risk of flipping — especially in a market like this that’s already risen a lot, very quickly — is that you’re stuck with an “illiquid” asset when the music stops. We’re not big believers in housing bubbles bursting like stock market bubbles. But hot housing markets eventually cool off —and they can do so quickly. If that happens while you’re still holding your “flipper” property — you could wind up selling at a loss just to get out from under those carrying costs.
Q: I am starting work as a consultant. The company that has hired me is offering salary plus per diem. Is per diem considered income? is it taxable or nontaxable?
-- Gregory H., Columbia, S.C.
A: Any money you get for work performed is income. If the money is paid to you as an employee, it’s wage income and goes on your 1040. If it’s paid to a consulting firm you own, it could be considered business income and accounted for in a variety of ways — depending on how the business is set up. (If you want to take that route, you should definitely consult a good accountant or tax attorney).
“Per diem” (from the Latin: “by the day”) usually refers to payments that are intended to cover daily expenses like meals and transportation. Companies do this because it’s a lot simpler just to pay you a daily lump sum than it is to set up an expense account, collect receipts, reimburse you for these expenses and keep records for their tax return.
But that per diem is still income. You can deduct any business expenses from that income, and you’ll need to keep good records and receipts (for three years after you file your return).
So if your expenses on any given day don’t use up your per diem, you’ll owe taxes on whatever is left over. On the other hand, if your daily expenses exceed the per diem, the added expenses will cancel out income on which you would have owed taxes.
As for what’s deductible, that’s been the subject of some of the taxpaying public’s most creative accounting. Like the store owner who tried to deduct his payment to an arsonist to torch the place or the guy who wanted to deduct dog food as a “security expense.”
If you’re going to go for deductions beyond the basics (out-of-town travel, lodging, meals, office supplies, etc.) you’d better read up on what the folks down at the IRS have to say about what is, and is not, a legitimate business expenses. (Publication 463 spells out the details.) In the section on entertaining clients, for example, you’ll learn that fishing bait for a trip to the lodge with clients is okay. But the cost of a rented luxury skybox is not. Go figure.
You’ll also find that even simple questions aren’t that simple once the IRS gets involved. But they’ve thought long and hard about all this and come up with more answers than we could fit in a year’s worth of this column. So before you get creative, check the IRS Web site: they’ve probably got it covered. (Like this handy chart which local travel expenses are deductible.)
OUR STOCK ANSWER
Q: When is Citigroup going back to those days of stock growth and splits? When can we expect it to reach $65 again? -- Neil H., Reading, Pa.
A: Sorry, we don’t comment on individual stocks. We figure there are already more than enough opinions on the subject. And the last place you want to look for stock recommendations is from some guy you've never met who writes on the Internet.
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