Flipping a House? What Are the Tax Consequences?
October 2, 2017
A "rehab and sell" - otherwise known as "flipping" a house can be a good way to make a profit if you have the right mindset and do your research. If you know how to find the right contractors, can do a good amount of the work yourself, and choose your location, you really can make money. Of course, there's also the perceived glamor supported by shows such as "Flip or Flop" - this attracts people to the business even if they might not have thought everything through.
However, any time you make money, you have to think about taxes. Yes, you should have a CPA, but you should also think about the tax implications.
How Long to Hold onto a Property
The biggest: How long you hold onto the property. Ideally, you should keep a house at least a year, which means you will pay no more than 20 percent tax (capital gains tax). Less than that and your profit will be taxed at ordinary income tax rates. Even worse, if the government decides you're running a business, you'll become liable for self-employment tax, which adds on another 15 percent (If you're self-employed, you pay both halves of the tax) - and they may decide it is business profit, not capital gains. If you flip one house, or do it occasionally, then you may not be considered a business.
There are a few things you can do. Living in the house you're flipping for two years will get it considered your primary residence and you can exclude up to $250,000 from tax, $500,000 for a married couple. Of course, that means dealing with all of the construction noise. Another trick is to do a 1031 tax-deferred exchange - you need to use a 1031 intermediary and find the next house within 45 days. You defer federal taxes until you sell the property outright - meaning you don't pay anything until you stop flipping houses. If you need to hang on to a property to be eligible for this, you can always rent it out - although becoming a landlord is stressful and not for everyone - or use it yourself. This might not work if your idea is to rehab one house, then live in that one while you do the next one.
Another thing to consider is the age of the property. The government likes people who fix up and renovate old buildings. If the house was built before 1936 you can get a tax credit of 10% of what you spend on rehabilitating it, 20% if it is a "certified historic structure." This only covers renovation and you have to keep the character of the building intact, but it might be worth it. Seeking out old buildings, though, is a specialist endeavor that means you need to do extra research and be particularly careful with any contractors you hire to do the work. However, it can be particularly rewarding and in some cities might even make you popular with the city and your neighbors - old neighborhoods often become run down eyesores in need of some major work.
Essentially, before you think about flipping a house you should do the basic research and then contact a qualified CPA (not just a "tax preparer"). Look for a CPA who already works with people who rehab properties for sale in your area, as they will know all of the implications and precedents. They can, for example, help you stay below the threshold of being considered a business (unless, of course, making this your business is your goal). If you are considering renting out a house instead of selling it, then make sure your CPA also knows how to handle rental income. Flipping a house can be rewarding and you can make money, but you need to know the tax pitfalls so you don't find that all of your profit is taken by Uncle Sam.