Taxes When Flipping Houses: A Comprehensive Guide

As a house flipper, you're likely aware that taxes can be a significant expense. You'll need to pay capital gains tax on the profit you make from selling a house, which is calculated as 20% of the gain.

The good news is that you can deduct expenses related to the sale of the property, such as real estate agent fees and closing costs, to reduce your tax liability. This can be a big help in minimizing your tax bill.

The tax implications of house flipping can be complex, but understanding the basics can help you navigate the process with confidence.

You need to consider whether the house you're planning to flip is considered inventory. Inventory is defined as property purchased with the intention of reselling it for a profit.

If you plan to purchase a house, fix it up, and resell it, then the house is indeed inventory. This means the sale of the house will be subject to self-employment tax, unless you're taxed as a C corporation or S corporation.

As a flipper, you're considered a dealer in that inventory, which affects how the house is taxed.

You'll need to pay capital gains taxes on profits from selling a property, which can range from 10% to 37% depending on your overall income.

A short-term capital gain applies to properties held for one year or less, and is taxed as regular income. You'll pay the standard income tax rate on short-term capital gains.

Long-term capital gains, on the other hand, apply to properties held for more than a year. These rates range from 0% to 20% depending on your taxable income and filing status.

Here are the tax rates for short-term capital gains in the 2022 tax year:

You may also have to pay state capital gains tax, and if your income exceeds $200,000 (or $250,000 if married and filing jointly), you'll need to pay the Net Investment Income Tax (NIIT).

An exchange can be a smart move for real estate investors. A 1031 exchange allows you to defer paying capital gains taxes on profits earned from selling a property.

You can reinvest those proceeds into another similar investment within 180 days after closing on your original sale. This essentially means rolling over your profits into another investment without having to pay taxes upfront.

You can keep pushing out your taxes to a later date, but all deferred taxes must eventually be paid when you close out your final sale without a 1031 exchange.

Capital gains taxes can be a significant tax consequence for fix-and-flip investors. A profit generated from the sale of a property is considered a capital gain, which can be taxed as either short-term or long-term capital gains.

Short-term capital gains apply to properties held for one year or less and are taxed as regular income, with rates ranging from 10% to 37% depending on the investor's overall income. The tax rate for short-term capital gains is generally consistent with the standard income tax rate.

Long-term capital gains, on the other hand, apply to properties held for more than a year and have rates ranging from 0% to 20%. The tax rate for long-term capital gains depends on the investor's overall income in the year they sell.

Here's a breakdown of the tax rates for short-term and long-term capital gains:

Long-term capital gains rates range from 0% to 20% and depend on the investor's overall income in the year they sell. If you own the property for over a year before selling, you'll pay long-term capital gains.

Investors who hold properties for under a year before selling have to pay short-term capital gains tax, which can be as high as 37%.

To qualify for primary residence tax benefits, you need to live in the house, and it's a good idea to do so for at least two out of the five years leading up to the sale.

You can exclude up to $250,000 of gain from the sale of your primary residence, and if you're married, you can exclude up to $500,000 if both you and your spouse lived in the house.

If you've sold a previous residence, you'll need to wait two years from that sale date before selling another primary residence to qualify for the tax exclusion.

You can avoid taxes on a flipped house by moving into it and using it as your primary residence for two years, which can exclude up to $250,000 of gain for single taxpayers and up to $500,000 for married taxpayers.

Claiming a house flip as a hobby instead of a trade or business can save you from self-employment tax. This might be a good option if you don't need the income to support yourself or your family.

To qualify as a hobby, the gain from the house flip should be unnecessary for your financial support or livelihood. Making a profit on the flip shouldn't be your primary consideration, and you should have spent a minimal amount of time and effort on the activity.

Here are the key factors to consider:

If you truly enjoy the work and are unsure if you'd even make a profit, you might consider claiming your activity is a hobby.

Claiming your house flipping activity as a hobby can be a viable option to avoid self-employment tax. However, it's essential to understand the IRS's criteria for determining whether an activity is a hobby or a business.

The IRS considers an activity a hobby if the gain from the house flip was unnecessary for your financial support or livelihood. If making a profit on the flip was not a primary consideration, you might be able to claim the activity as a hobby. This could be the case if you spent a minimal amount of time and effort on the activity or had no business plan or projection that showed the activity would be profitable.

To qualify as a hobby, you don't need to answer "yes" to all of these questions, but not being motivated by making a profit is a crucial determining factor. If you truly enjoy the work involved with flipping a house and are unsure if you'd even make a profit, you might consider claiming your activity as a hobby.

Here are the key factors to consider when deciding whether your house flipping activity is a hobby or a business:

Keep in mind that you can't simply claim your house flipping activity as a hobby if you're making a significant profit. The IRS will scrutinize your activity, and if you're found to be operating a business, you'll be subject to self-employment tax.

Flipping your own home can be a great way to get started with house flipping, especially if you're not relying on it as your main source of income. You can reduce taxes on a sale by using the Section 121 exclusion.

This exclusion allows you to exclude up to $250,000 of the gain on your taxes, or up to $500,000 if you're married and filing jointly. To qualify, the house you're flipping has to have been your primary residence for at least two of the five years leading up to the sale.

You can't use the Section 121 exclusion if you already used it in the last two years on another home.

Forming a business entity for your house-flipping business can be a game-changer for tax purposes. This can help remove personal liability for its success or failure, and also offer privacy and safeguard assets.

An LLC or S corporation can be a good choice, as they are considered flow-through entities. This means that income flows through to the owning members and is taxed as individual income.

The main advantage of an LLC or S corporation is that they are not subject to double taxation. Unlike C corporations, which are recognized as separate tax-paying entities and subject to double taxation.

Here are some key differences between LLCs and S corporations:

As a house flipper, operating under a separate business can help offset certain taxes. For example, electing S Corporation status can reduce the amount you pay in self-employment tax by taking part of the profit as a salary and the rest as a distribution.

If you elect S Corporation status, you can reduce the amount you pay in self-employment tax by taking part of the profit as a salary and the rest as a distribution.

As a house flipper, you're entitled to claim many business expenses as tax deductions. These deductions can significantly reduce your overall taxable income, leaving you with more money in your pocket.

The IRS allows you to deduct expenses related to purchasing a property and making upgrades, but you can't deduct these expenses from taxes before selling the property. This means you'll need to wait until you sell the property to claim these deductions.

You can also deduct office expenses, such as business cards and office supplies, to conduct business. Operational expenses for an off-site office, including rent, utilities, phone, and internet, are also deductible. For a home office, you may deduct a percentage of the house's expenses based on the square footage of your office relative to the entire house.

Vehicle expenses can be claimed for business travel, even if you conduct the travel with a personal vehicle. You can use the standard mileage rate, which is 67 cents per mile in 2024, or deduct actual vehicle expenses, including maintenance, repairs, oil, and fuel.

Interest payments for fix-and-flip loans are eligible expenses, making short-term financing more accessible. You can also deduct miscellaneous expenses such as property taxes on the investment property, building permit costs, real estate commissions, and legal and accounting fees.

To keep track of deductible expenses, it's a good idea to set up a separate checking account for each property. This will help prevent commingling expenses from multiple properties, which could lead to confusion and tax issues.

Here are the main categories of eligible expenses:

So you're flipping houses and wondering how it affects your taxes? If you purchase real estate intending to resell it in the short term, then you are a real estate dealer and any profit from the flip is ordinary income.

The IRS classifies real estate investors and dealers differently. A real estate investor is someone who owns and holds properties long-term, while a real estate dealer purchases and sells properties quickly and repeatedly.

As a dealer, the government may categorize your house flips as dealer activities, which can increase how much you pay in taxes. If the IRS classifies your house flips as dealer activities, it can increase how much you pay in taxes.

Being aware of this classification is crucial, as it can impact your tax burden.

As a frequent house flipper, it's essential to have a solid tax strategy in place. You can't avoid paying taxes on your profits, but there are ways to reduce your tax burden.

If you flip houses frequently, your homes are considered inventory, and your profits will be taxed as ordinary income. There is no way to avoid this. However, you can still minimize your tax liability through strategic planning.

You can reduce your overall tax burden by employing tax-saving strategies, even if you don't qualify for the same tax benefits as long-term investors. This includes consulting with a professional tax advisor and attorney to ensure you're making informed decisions.

As a one-time flipper, you're likely looking for ways to minimize your tax liability. Many learn that house flipping isn't for everyone after their first attempt.

If you decide to sell the house as originally planned, you'll owe a mountain of tax. Converting the house from inventory to a primary residence can be a smart move.

To qualify for primary residence tax benefits, you must live in the house for at least two of the five years leading up to the sale. This can be a significant tax savings.

Alternatively, you can convert the house to a rental property, which can provide a steady stream of income and potential tax benefits. However, you'll need to meet certain requirements to qualify for rental property tax deductions.

The key is to hold onto the house for at least a year before renting it out to qualify for the 20% depreciation deduction. This can help offset the mortgage interest and operating expenses.

As a frequent house flipper, it's essential to consider tax-saving strategies to reduce your tax burden.

If you flip houses frequently, then the houses are undoubtedly inventory—and there is nothing you can do to avoid profit being taxed as ordinary income. You can't escape paying taxes, but you can minimize the impact.

Even though most house flippers don’t get the same tax benefits as long-term investors, there are still several things you can do to reduce your overall tax burden.

There are several tax-saving strategies to reduce your taxes, which you can explore with your professional tax advisor and attorney.

Make sure you speak with your professional tax advisor and attorney before buying a house you want to flip, as this article isn’t meant to be taken as personal legal or tax advice.