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Any experienced real estate investors will tell you - taxes due on flip can have serious impact on your cash flow and profitability. Without proper planning and not understanding the tax implications on flip properties can have grave consequences on your tax burden and often is very steep.
Flipping houses is considered a lucrative business, but it is also a costly endeavor with numerous expenses that can be incurred along the way. If you are planning to get into the flipping business, you will need experience, funds to operate, and knowledge to successfully plan out the business. In this article, we delve into a rundown of what the options are and why taxes matter for your operations.
The first thing you should know is the difference between a real estate investor and a dealer. Yes, there is a difference between both, although both seem to be doing the same thing.
Investors usually use their property for rental income and as an asset; they increase the value of their property slowly over the years. They hold their property for a minimum of a year.
On the other hand, a dealer is a traditional house flipper. They buy the property to resell it and gain quick profit. The IRS (Internal Revenue Service) has defined some criteria to determine if you are a dealer:
There are two types of capital gains taxes: short-term and long-term. These taxes are applied according to the nature of the real estate business you are in. Short-term capital gains taxes are taxed at the same rate as your income tax rate and are for profits on assets that are sold within less than a year. However, long-term capital gains taxes are for assets that are held for over a year and are charged at a more favorable rate, which ranges from 0% to 20%depending on the tax bracket.
House flipping does not fall under capital gain treatment. Dealers usually purchase the property and quickly resell it to make a profit. The longer they hold the property, the more they lose profit. Dealers should also be aware that, other than the ordinary income tax, they must bear self-employment taxes. This means that the profit made from flipping is subject to your standard taxation rate because the IRS classifies any flipping income as self-employment income.
In general, house flippers face higher taxes than investors, but there are ways to lower your flipping tax burden. Here are some ways to minimize taxes on flipping houses:
1. Setup Your Business (chose right entity)
It is wise to establish your business before investing in house flipping. A Limited Liability Company (LLC) is a popular business structure that allows you to deduct business expenses. Other benefits of LLCs (limited liability companies) are that you can later change this to S-Corp to save self-employment taxes.
Important reminder: Never own rental properties in the same S-Corp/LLC that does the flips.
2. Tax Deductions
You can write off many expenses of your house flipping business. Here are some common tax deductions you may be able to make:
3. Losses Deduction
Businesses are always at risk of losses; you may not make a profit every time in the house flipping business. The benefit is that you can deduct any losses you face and use them to offset your other income.
Internal Revenue Code Section 1031(a)(2) has specifically outlined the incompatibilities. Properties held primarily for sale do not qualify for the 1031 exchange benefit. The reason for this is because they do not meet the IRS like-kind exchange criteria of "held for trade or investment." Real estate flipping mostly focuses on quick resales rather than the long-term holding of the property.
To get the full benefit of this, you should consider the help of a CPA. We at Investor Friendly CPA® consist of expert professionals who are real estate investors themselves. We can provide you with knowledge and guidance that can help you and your flip business. We understand that taxes are complex, so we are always ready to help you.
Talk with your financial advisor about the best way to offset these gains with losses and whether you qualify for a capital loss carryover.
Itis important to note that the determination of whether someone is engaged in areal estate business is based on the facts and circumstances of each individualcase. If you are unsure about the tax implications of your real estatetransactions, it is important to seek professional advice and guidance.
Investor Friendly CPA is devoted to serving the real estate industry. We provide proactive solutions to the accounting needs of investors, developers, contractors, and other industry constituents
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