Sep 8, 2022
Grant Murphy
Welcome to our comprehensive guide on 'Flipping Homes: The Tax Implications to Consider'. This post aims to provide insights into the key tax rules and potential liabilities that come with house flipping. Both novice and seasoned investors can benefit from this information to maximize profits and limit tax liabilities in the real estate flipping market.
Understanding Capital Gains Tax
The profits you make from house flipping are classified as capital gains. If you sell a property that you've owned for less than a year, you could be liable for short-term capital gains tax, which can be as high as 37%. However, if you hold the property for longer than one year before selling, it's classified as a long-term capital gain, taxed at a reduced rate (up to 20%).
Taking Advantage of the Depreciation Law
Depreciation is a tax deduction that allows real estate investors to recover the costs associated with property wear and tear. Under the IRS Code Section 179, certain types of property improvements are also eligible for deductions. Taking advantage of such provisions significantly lowers your overall tax liability.
Navigating Self-Employment Taxes
Regular house flippers may be considered self-employed by the IRS, which would require them to pay self-employment tax. While this may increase your tax liability, there are several business expense deductions available that can offset this. Consulting with a tax professional can be beneficial in understanding these nuances.
Understanding the 1031 Exchange
The Section 1031 exchange, also known as a like-kind or Starker exchange, is an excellent tool for deferring capital gains tax. This provision allows investors to reinvest the profits from a sold property into another of 'like-kind', postponing the need to pay capital gains tax, value for value.
Property Flip as a Business
If you're flipping properties as a business, your income would be subject to regular business taxes. In such cases, it is possible to deduct necessary and ordinary expenses incurred during the flipping process. Such expenses can include renovation costs, marketing expenses, and even vehicle mileage.
Conclusion
Flipping homes can be an excellent investment when done right, and a big part of that is understanding the tax implications. By familiarizing yourself with the capital gains tax, depreciation laws, and tools such as the Section 1031 exchange, you can better position yourself to maximize profits and mitigate tax liabilities in the real estate flipping market.
We always recommend consulting with a tax professional to make sure you're taking full advantage of the tax benefits available to you and staying compliant with the law. Happy house flipping!