Tax considerations when deciding to flip a home
When people get into the business of flipping homes they often think it's going to be a quick profit, but this is not always the case. The truth is there are several costs involved with flipping a home, such as holding costs, the cost of the actual renovation materials and labor, as well as taxes. A home flipper's goal is to have their home renovated, on the market, and sold as soon as possible. But with the sale of the home comes the profit, and with the profit comes taxes.
The amount of tax you pay on flipping a home depends on how you flip, when you sell, and if flipping homes is your primary income. Before you decide to get into the business of flipping homes decide if it's right for you with this quick tax checklist.
3 questions to ask yourself about tax laws when flipping a home:
How will you pay capital gains tax? According to RealEstate.com, how you pay capital gains tax depends primarily on how long you hold your property. Flippers pay lower capital gains rate on properties that are held for at least a year. If you flip your home and sell it in less than a year you will have to pay the long-term capital gains rate. This can quickly add up on your tax bill because it is the same percentage as your regular marginal income tax rate.
What type of flipper are you? When the IRS is deciding how you will pay capital gains tax they have to decide if you are a real estate dealer or a real estate investor. A dealer is someone who makes their primary income from flipping homes and they usually hold their properties less than a year. If the IRS considers you to be a dealer than all profits will be treated as ordinary income and you will be taxed on profits in the current year.
A real estate investor is someone who holds their properties for more than a year and usually has another full time job. If the IRS considers you to be a real estate investor capital gains will be taxed at a lower rate on property you hold for at least a year. The advantage here is capital gains can be deferred indefinitely by using a 1035 exchange.
Do you also rent your properties? If you are a landlord as well as a flipper the IRS may tax you differently than a regular real estate investor - across all your properties, not just those you've flipped and rented. Avoid this by holding your flipping properties separately from your rentals.
With tax information in hand, you can proceed with financial confidence into your next (or first!) real estate deal. Consider getting in touch with your accountant before purchasing a property to get all the details on your particular tax situation.