The number of home flipping sales is on the rise. As the real estate market across the country is booming, house flipping is becoming a lucrative job option.
However, there is still a lot of confusion around taxes and flipping houses for profit. Read on to learn more about taxes on flipping houses.
Flipping Houses and Capital Gains Rules
In many cases, real estate is considered a capital asset, and the sale of the home can qualify for preferential capital gain tax rates. However, when you’re in the trade or business of flipping houses for profit this may not be the case.
Normally, if you purchase a piece of real estate to fix up and sell it at later date, the profit is taxed under the capital gains rules. There are even more favorable rules if the property qualifies as your principal residence. If you live in it more than two years during the five-year period preceding the sale, you can often exclude the gain from taxation altogether under special rules for homeowners.
However, the IRS classifies individuals who actively purchase and remodel real estate for profit on a continuing basis as dealers rather than investors. For these people, the real estate is treated as inventory, rather than capital assets, and the profits on the sale of those properties is treated as ordinary income, subject to the self-employment tax.
Rolling Proceeds to Avoid Taxation
Another source of confusion is that many potential flippers believe they can avoid taxation if they roll the proceeds of the sale into purchasing another project to flip (i.e., the property ladder theory). The truth is, if you’re considered to be in the trade or business of flipping real estate, this is not possible, as this treatment isn’t allowed for property held for resale.
Flipping Houses: Tax Deductions
House flipping is obviously a costly business, with numerous expenses incurred along the way. If you are operating as a business you may think you can find tax deductions to lower your tax obligation. Unfortunately, most of the home flipping expenses are not immediately tax deductible. Instead, they must be capitalized into (i.e. added to) the basis (the original value) of the residence. Capitalized costs include:
The cost of the home itself
Production period interest
Real estate taxes allocable to each project
You then get a tax benefit from these expenses when you sell the property as the taxable gain is reduced by the amount of basis in property.
Consult a tax pro who specializes in this area for more guidance on flipping houses and tax deductions.
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