As experienced real estate investors will attest, taxes due on a fix and flip can have a serious impact on profitability. While these types of real estate investments are great for quickly unlocking value, the taxes on flipping houses have to be considered and calculated at the start of every project. Without a proper plan, the tax consequences of flipping homes can be steep. Thankfully, however, there are different strategies available to help you save money. In this guide to expert tax strategies for flipping houses, we give you a rundown of what your options are. NEED ADVICE? SPEAK WITH A SEASONED LOAN OFFICER TODAY Or if you’re looking for other tax advice, read ourguide to cash out refinances and taxes. Before we discuss strategies, it’s important to understand the difference between the taxes on flipping houses and long-term rental taxes, and why there is such a disparity between them. The standard tax consequences of flipping a house, where you own the property for less than 12 months, is that the profit you make is subject to your standard taxation rate. This is due to the fact that the IRS classes any investment you own for less than a year then sell for a profit as ‘normal income’. Moreover, if this is the case, the IRS categorizes you as “a dealer”, even if you may not consider your real estate investment as a ‘business’. You may work a full-time job and just flip houses as a side hustle. However, this doesn’t matter to Uncle Sam.
Taxes on flipping houses and long-term rental taxes – where do they differ?
On the other hand, landlords are viewed differently. They’re considered long-term investors and are thus granted preferential tax treatment. That being said, don’t let this discourage you from fix and flip investing. There are tax strategies available that can reduce your liability.
Keep Hold of the Property For Over a Year
As mentioned, the reason why taxes are so high for standard fix and flips is due to the quick turnaround.
To demonstrate this, let’s look at two scenarios and the differing capital gains tax on flipping real estate:
- You’ve owned a property for 11 months and sell it for a profit –This profit is classified as a short-term capital gain. Therefore, it’s taxed at your ordinary-income tax rate.
- You own the same property for 13 months and then sell it on –Your profit is now classified as a long-term capital gain and is taxed at a lower rate (see below).
What difference does this two-month window make? Quite a bit.
Short-term capital gains are taxed at your normal income tax rate. At the time of writing, federal income tax ratesrange from 10-37% of your income. Moreover, due to being classed as a “dealer”, flippers have to pay doubleFICA taxes. Usually 7.65%, this shoots up to 15.3%. Combined, this results in a taxation rate between 25.3% and 52.3%.
On the other hand, long-term capital gains are not subject to FICA taxes and the tax on flipping houses owned over a year is between 0-20%.
If you’re looking to avoid a large tax bill, it may be worth revising your exit strategy to the 12-18 month window. If you’re going to acquire financing froma private money lender, you can explore the possibility of a longer loan window. However, if your window is shorter than a year, you can refinance your loan. Before making any big decisions, speak to your lender as they most likely have experience in different tax strategies.
Look into a 1031 Exchange
If you’re looking to continually fix and flip and make your side hustle a full-time job, a 1031 like-kind exchange is a great tax strategy for flipping houses.
Ina 1031 exchange, you can defer capital gains tax liability on the sale of an investment property. In return, you use the proceeds from the sale to buy a new property. If you do decide to use this kind of exchange, you need to make sure you follow certain steps and hit your time frames. This can be difficult if you’refix and flipping during COVID-19.
If you do want to go down this route, you need to have a top real estate team on hand for advice and have an experienced tax professional in your corner.
Take ALL the deductions available to you
If you’re unable to do the above but have decided to make flipping houses a legitimate business, you want to ensure you take every single tax deduction that may be available to you.
These may include:
- Real estate taxes
- Labor cost
- Utilities
- Office expenses
- Mortgage interest accrued while you held the property (if you go through traditional financing)
- The home’s purchase price
- Materials cost
In addition, we always recommend you keep close track of your expenses. That way your accountant can accurately deduct your expenses from your gross profit and you only pay taxes on your net profit.
WE LEND OFFERS A RANGE OF PROGRAMS TO SUIT EVERY TYPE OF RESIDENTIAL REAL ESTATE INVESTOR.
The Bottom Line
The taxes on flipping houses can be substantial. However, there are strategies available that lessen the tax consequences of flipping homes.
In addition to following our tax strategies for flipping houses, you should find the right people to advise you on taxes and anything else you may need to make your fix and flips a success.Experienced private money lenders, real estate agents, contractors, and tax professionals, to name a few.
If you do, you’ll spend less time worrying about Uncle Sam and more time flipping properties for profit.
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As an expert in real estate investing with a keen understanding of tax implications, I have actively navigated the intricate landscape of fix-and-flip projects. My hands-on experience in the field, combined with an in-depth knowledge of tax regulations and strategies, positions me to provide valuable insights into optimizing profitability while minimizing tax liabilities.
In the realm of fix-and-flip ventures, taxes play a pivotal role in determining the ultimate success or failure of a project. The article rightly emphasizes the significance of considering tax implications from the outset, highlighting the potential impact on profitability. I will dissect key concepts touched upon in the article to shed light on effective tax strategies for individuals engaged in flipping houses.
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Differentiating Between Fix-and-Flip and Long-Term Rental Taxes: The article underscores the distinction between taxes applicable to fix-and-flip endeavors and those related to long-term rental properties. Short-term capital gains, incurred when selling a property owned for less than 12 months, are subject to standard income tax rates. In contrast, long-term investors, such as landlords, benefit from preferential tax treatment.
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Hold the Property for Over a Year: One strategy to mitigate tax burdens is to extend the holding period beyond 12 months. By doing so, profits qualify as long-term capital gains, subject to lower tax rates ranging from 0-20%. The article rightly points out the significant difference in tax implications between short-term and long-term capital gains, showcasing the potential for substantial savings by adopting a more extended investment horizon.
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1031 Exchange for Continuous Fix-and-Flip: For those transitioning fix-and-flip projects into a full-time business, a 1031 like-kind exchange emerges as a powerful tax strategy. This allows the deferral of capital gains taxes by reinvesting proceeds from a property sale into a new one. The article emphasizes the importance of expert guidance and adherence to specific steps and timelines in executing a successful 1031 exchange.
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Maximizing Deductions for Flipping Businesses: The article underscores the importance of treating fix-and-flip activities as a legitimate business. This approach opens avenues for various tax deductions, including real estate taxes, labor costs, utilities, office expenses, mortgage interest, purchase price, and materials costs. Keeping meticulous records of expenses is highlighted as crucial for accurate deduction calculations.
In conclusion, the bottom line is that taxes on flipping houses can be substantial, but strategic planning and adherence to specific tax-saving methods can significantly alleviate the financial impact. Engaging with experienced professionals, such as private money lenders, real estate agents, contractors, and tax experts, is crucial for ensuring a comprehensive and successful approach to fix-and-flip projects.
