How much will you pay in taxes flipping a house?

Flipping a house can mean a big payday.

But the government wants their share TOO!

And avoiding those taxes can mean a visit from the IRS.

So as service providers (a direct mail company), that services house flippers, we want to help you fully understand the tax rules of flipping houses (because we’re also flippers ourselves).

Before we go on understand this:

[We are NOT tax consultants, CPAs, tax professionals, or lawyers. You SHOULD seek any legal and tax advice from a licensed professional. This article is for entertainment purposes and not to be taken as legal or tax advice…]

Ok, so we got that disclaimer out of the way, and if I haven’t scared you off just yet and you’re still listening, let’s get to what we’ve experienced and understand about the taxes you’ll be paying as a house flipper.

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What kind of taxes do house flippers pay?

The IRS calls it “capital gains tax”.

And there 2 types:

  1. Short-term capital gains — As high as 37% of your NET profit
  2. Long-term capital gains — As high as 15% of your NET profit

These ALSO apply to stock investing but for the purpose of this article, we’ll just talk about real estate.

Short term
If you’ve owned a property for LESS than 1 year, you’ll fall under the “short-term capital gains” bracket.

Long term
If you’ve owned a home for more than 1 year but less than 2, you’ll fall under the “long-term capital gains” bracket.

This is extremely important to know when you’re flipping a house. It can mean a difference of paying out $7,500 in taxes, vs $18,500 on a $50,000 net profit (that’s a huge difference in your profit).

And you should know this BEFORE stepping into a real estate deal. The IRS doesn’t care what you did to the property; if you flipped or rented it as-is. If you sold the property and never lived in it, AND you made a profit, they want your share no matter your exit strategy.

Can you get away with NOT paying taxes on a flipped house?

If you’re wondering if you can make your “payday” on a flipped house “under the table”… the answer is NO if you went through title and escrow.

A title and escrow company report all sales and transactions.

So if you sold a property the IRS will know.

So you can’t get away from it.

Bottom line: Pay your taxes.

The only way to get away from paying taxes (other than not going through escrow and title), is by keeping within the IRS definition of what’s considered “capital gains”.

And they say this (taken straight from the IRS website):

“If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse”

A capital gain is classified as this (taken straight from the IRS website):

“You’re eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale.”

What on earth does that mean?

Well, if you owned the property for more than 2 years, AND you lived in it for at least 2 years out of the 5 years since owning it, AND the net profit was LESS than $250,001 (or $500,001 if married)… then you won’t pay any taxes on that sale.

Here are some examples of how this works:

  1. You are your spouse buying a house to “house hack” (live-in-flip). After 2 years, you decided to rent it out. Another 2 years go by (4 years total), and you decide to sell. You make a $50,000 NET profit. So, because living in it was under 2 years (not more than 5), you are EXCLUDED from any taxes.
  2. You buy a property to Brrrr. You place tenants in it. After 2 years you sell it. You are NOT excluded from capital gains tax because you never lived in it. So because it was longer than 1 year, you’ll only have to pay long-term capital gains tax
  3. You buy your primary residence. After 2 years of living in it, you decided to rent it. 8 years go by after renting it and you decide to sell it. You are NOT excluded from a tax because it was more than 5 years ago that you lived in it. So you’ll pay long-term capital gains.
  4. You aren’t married and you buy a primary residence to live in. After 2 years of living in it, housing prices SOAR. And you have the ability to sell now and make $260,000 NET on the appreciation. If you sell and net that much, you’ll pay long-term capital gains tax on $10,000.
  5. You buy a house to flip. And things take a little longer than expected. You end up only selling AFTER 1 year of owning it. You still pay taxes on your net profit, but you’ll only pay the long-term capital gains tax vs the short term which can be more than double.
  6. You buy a property to place tenants in it, so it’s now rental property making money. After a couple of years, you decided you want to live in it. So you live in it for 2 years but then sell it. You are EXCLUDED from paying taxes because you lived in it for 2 years within 5 years of owning it.

Hopefully, those clarify the IRS rules for you, but knowing this can mean determining how you plan your investment strategy.

Flipping Strategies to avoid paying heavy taxes

If you’re a volume flipper

Most reading this don’t fall into this category, but you might fall into it later if you choose to be a professional house flipper.

Most professional house flippers can’t afford to wait a full year to sell. They typically use private money loans or hard money loans which can get VERY expensive the longer it takes to pay them back (plus they sometimes have ballon-payment terms).

And if they are using their own money, well they can’t afford to keep their cash sitting there either. Because they’ll make more money using that buying capital to flip 2-3 more properties in the year, than save on short-term capital gains tax (they’d rather just pay their taxes now than keep their money from making more money)

But for professional flippers, you CAN implement a strategy of keeping 1 house you flip to lower your tax bracket. Keeping 1 house as a rental can mean not paying short-term capital gains, and growing your wealth with a rental

For house hackers

House hacking is when you buy a property to flip BUT you live in it. This has extraordinary benefits because you can get yourself a traditional primary residence loan that requires a small down payment (anywhere from $0 to 5% down depending on the loan) rather than a typical 20% required down payment. And you can exclude yourself from ANY capital gain if you sell after 2 years but before 5 years since living in it.

So if you LACK funds, use the “house hack” strategy to avoid taxes.

For hobbyist

If you’re dabbling in “house flipping” you may want to consider extending the project to at least 1 full year since owning it. If you’re not ever living in it, you can’t avoid paying taxes. But you can decrease the amount of taxes you pay significantly just by holding on to the property for more than 1 year. And, typically, if you’re doing this to try it out and make extra income, it doesn’t hurt UNLESS you have a pricey loan and comes with a short balloon payment

(Ballon loans mean that the full amount of the loan is due before it’s full amortized. So for example, you have a loan that’s amortized for 30 years but has a ballon in 15. That means your monthly payments are calculated as if it’s a 30 year loan, but the FULL loan is DUE in 15 years no matter how much is left. So if you have $200,000 left in this loan and you reach the 15 year mark, $200k is due.)

Some tax deductions to lower your taxes while flipping houses
While you can’t avoid the capital gains tax when you flip a house (with a few exceptions mentioned above), you LOWER your tax bracket and pay less in your monthly income tax.

(Capital gains tax is like your “sales tax”)

Capital gains vs income tax

Income tax is what YOU or your entity (your LLC, Corp, etc) pays on the income you made for the year. What you pay in income taxes depends on what tax bracket you’re in (we’ll cover ways to lower this later). Income is classified under the forms of employment, interest, dividends, royalties, or self-employment, whether it’s in the form of services, money, loan interest, or property rental income.

Capital gains tax is more like a “sales tax” and it’s taxing on a SALE or exchange of an asset when there’s a profit.

Lowering capital gains tax
While we already covered how to avoid paying short-term capital gains and paying the lesser long-term tax instead (or excluding the tax altogether with “live-in” loopholes)…

There’s no way to actually lower the percentage you’re stuck with.

But there are ways to lower the amount of taxes you pay by lowering your net profit/gains on “paper”.

What the IRS determines is your “NET PROFIT” is AFTER you consider all the expenses you paid on that flip.

When doing a flip, there are expense deductions you can make. When purchasing an investment property such as rental homes or vacation rentals, investors can deduct certain expenses associated with improving and maintaining their properties. These include repairs, renovations, furnishing costs, insurance premiums, security systems, etc.

These can deduct the capital gains of that single asset… or the overall annual income of you or your business entity (but it’s better to deduct the capital gains over your income unless you’re in a high tax bracket — consult a CPA for advice on this).

Lowering taxable income
When you’re running a house-flipping operation, then you have a business entity where you can lower your taxable income by making expense deductions.

NOTE: this is NOT lowering your capital gains. (As noted earlier, capital gains is like the sales tax of a single asset, and income tax is your annual income and the tax on it). Income from a rental property would fall under this.

Here are some examples of deductible expenses when it’s used for the business:

  • Rent
  • Office Supplies
  • Property management
  • Property maintenance
  • Tools
  • Software (when it’s for the business)
  • Marketing
  • Contractors
  • Phone
  • Loan interest paid out
  • And much more…

Depreciation as a tax deduction when flipping houses

One of the most popular tax loopholes available to real estate investors is depreciation deductions. Investors can also claim depreciation deductions each year based on their total purchase price; this includes any improvements made during ownership such as new roofing or flooring installation costs. By taking advantage of these deductions, investors can significantly reduce their overall taxable income by writing off part of their expenses every year!

Here’s a video that explains the depreciation tax deduction in more detail:

Avoiding paying taxes with an exchange

Another common tax loophole for real estate investors is taking advantage of 1031 exchanges when selling properties. A 1031 exchange allows investors to defer paying capital gains taxes on profits earned from selling a property IF they reinvest those proceeds into another similar investment within 180 days after closing on their original sale.

It’s essentially “rolling over” their profits into another investment without having to pay taxes upfront; however, ALL deferred taxes must eventually be paid when they close out their final sale without a 1031 exchange. Consult a CPA for this but you can essentially keep “pushing out” your taxes to a later date.

Here’s a video that explain 1031 in more detail:

Summary

Flipping real estate can be an incredibly rewarding experience if done correctly. It’s important to remember that all profits made from flipping real estate are taxable; however, there are certain tax loopholes that savvy investors can take advantage of in order to reduce their overall taxable income such as depreciation deductions and 1031 exchanges. By understanding these rules and leveraging available loopholes when necessary, you can minimize your tax liability while maximizing your profit potential! So get out there – do your research – and start flipping houses! Good luck!

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