Do house flippers pay capital gains?
Long-term capital gains taxes are for assets held over a year and are charged at a more favorable rate, ranging from 0% – 20% depending on the bracket. House flippers are mostly going to fall into the camp of short-term capital gains.
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
The 70% rule helps home flippers determine the maximum price they should pay for an investment property. Basically, they should spend no more than 70% of the home's after-repair value minus the costs of renovating the property.
Flipping houses is generally not considered passive investing by the IRS. Tax rules define flipping as “active income,” and profits on flipped houses are treated as ordinary income with tax rates between 10% and 37%, not capital gains with a lower tax rate of 0% to 20%.
Passive vs.
Active income is money that you earn in exchange for the work that you perform. That includes your salary from work, as well as the profits you make flipping houses. Flipping is considered active income, regardless of whether you are doing the physical labor of stripping floors.
Where to report in the tax return. A taxpayer who is a sole proprietor and whose business is buying and selling homes should report that activity on Schedule C. The homes they purchase, improve, and offer for sale will be their inventory.
Deferring Capital Gains Tax: Buying another home after selling an investment property within 180 days can defer capital gains taxes.
In rare cases, this can be illegal, according to the Federal Bureau of Investigation. However, they note that the illegality stems from artificial price inflation and minimal upgrades. Essentially, they view this as a way to scam other people out of the money that they're paying for that property.
The average ROI was -4.1%, and losses averaged out to $18,640. Five of the 10 worst markets for house flipping by ROI in 2023 were in Texas. Data source: ATTOM Data (2024).
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.
How do house flippers pay themselves?
Some house flippers choose to pay themselves between 10% and 30% of the total profits generated. Make sure you have a business bank account to pay yourself from. It's advisable to do this for LLC's particularly, and to keep your business and personal financials separate.
- Hold onto taxable assets for the long term. ...
- Make investments within tax-deferred retirement plans. ...
- Utilize tax-loss harvesting. ...
- Donate appreciated investments to charity.
The Financial Risk: Understanding the Costs
Foremost among the risks is, of course, the financial factor. Underestimating the renovation costs, unexpected expenses catching up, or holding onto a property for too long can swiftly turn a hopeful flip into a draining money pit.
While ZipRecruiter is seeing annual salaries as high as $119,000 and as low as $36,000, the majority of Real Estate Flipping salaries currently range between $64,500 (25th percentile) to $100,000 (75th percentile) with top earners (90th percentile) making $119,000 annually across the United States.
Short-term capital gains taxes are taxed at the same rate as your income tax and are for profits on assets (like real estate) that were held for less than a year. Long-term capital gains taxes are for assets held over a year and are charged at a more favorable rate, ranging from 0% – 20% depending on the bracket.
How much profit should you make on a flip? On average, a rehabber shoots for a 10 to 20% profit of the After Repair Value, but it varies depending on the market and the specific project risks. A 10% profit would be on the lower end, and a 20% profit would be considered a 'home-run' by most rehabber's standards.
The FHA flipping rule states that any FHA-insured mortgage cannot be used to purchase a home that has been flipped within 90 days of the sale. In other words, a seller must own the property for at least 90 days before it can be sold to an FHA borrower.
Typically, house flipping is not considered to be passive investing by the IRS, and as active income, the investor will need to pay normal income taxes on their net profits within the financial year. These taxes commonly include federal income tax, state income tax, and taxes for self-employment.
One of the biggest risks is that you could end up losing money if you're not careful. It's important to do your research and have a solid plan before you get started. If you're not experienced in flipping homes or real estate investing, it's probably not a good idea to go it alone.
Since the tax break for over 55s selling property was dropped in 1997, there is no capital gains tax exemption for seniors. This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
Can you avoid capital gains tax if you reinvest?
Reinvest in new property
The like-kind (aka "1031") exchange is a popular way to bypass capital gains taxes on investment property sales. With this transaction, you sell an investment property and buy another one of similar value. By doing so, you can defer owing capital gains taxes on the first property.
(Illegal) Property Flips
Some of the following red flags may occur in flips: Ownership changes two or more times in a brief period of time with the property value increasing significantly. Two or more closings occur almost simultaneously. The seller has owned the property for only a short time.
- Owner listed on appraisal and/or title may not match the seller on the sales contract.
- Refinance transaction used to pay off private short-term financing.
Live in flips are a slower strategy than regular house flips because investors are required to live in the property for 2 years or more, and the renovations must be done around them. Regular house flips can take just a few months, while live in flips typically take a few years.
The Best (and Worst) States to Flip Houses
Louisiana is the best state for flipping houses in the U.S. with a score of 41.1 out of 50. This is largely due to the state's high house flipping ROI of 55.6%. Fixer-upper homes in this state are also priced reasonably at $196,763.
References
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