House Flipping Taxes 101

Spurred by the popularity of reality TV home-flipping shows, individuals and businesses alike have taken advantage of different business models to flip homes and turn a profit. Many factors go into choosing to flip a home: the real estate market, the housing market in the specific local area, the cost of materials, and so on. However, all house flippers have one thing in common—taxes!

When done properly, a house flip can result in a large profit. To maximize profits and protect investments in the property, home flippers should educate themselves on the tax consequences of a home flip and the best practices to minimize exposure to tax. 

When Will Taxes Be Paid on a House Flip?

First, local property taxes will be applied. These taxes are typically imposed on an annual basis by the city, county, and/or state. To find information on the applicable local tax rates property owners should refer to the state and local valuation boards and other taxing entities. 

Second, taxes on any gain resulting from a home flip are due when the home is sold. If you purchase a home in early 2022 for $100,000 and sell it late 2023 for $300,000, taxes on the increased value of the home are unlikely to apply until it is sold. In 2023, the property owner will be taxed on the increased value of the home— $200,000.

No taxes will be due on the sale of the home if it is sold at a loss. Instead, taxpayers will report the loss on their tax return at the end of year.

How Much Will the Taxes Be on a House Flip?

To determine the taxes owed from the house flip the taxpayer must first establish whether or not they are considered a “dealer” of property. If a taxpayer is considered a dealer, they will be subject to ordinary income taxes. If a taxpayer is not considered a dealer, they can take advantage of the more favorable capital gains tax rate.

Determining if the Taxpayer is a Dealer

A dealer of real estate is generally a taxpayer who purchases a home as part of their business to quickly remodel the house and then sell it for a profit. Some common factors that are considered when determining if the taxpayer is a dealer are:

• The length of time the taxpayer held the property. Holding a property only for a short period (typically less than a year) before selling it is generally associated with a dealer classification;
• The extent and nature of the taxpayer’s efforts to sell the property;
• The extent of advertising, developing, and subdividing to increase sales and profit;
• How frequently the taxpayer sells property—e.g., selling a home once every three years may not rise to the level of a “dealer,” but selling a home every single month would likely support a finding that the taxpayer is a dealer;
• The taxpayer’s intent—if they intend to purchase the home as part of their inventory of homes to flip and sell for a profit, they will be more likely to be classified as a dealer.

A business or individual that is consistently flipping multiple houses in a period of less than a year with the intent to make profit is almost certainly going to be classified as a dealer. Even an individual or business who flips homes less frequently may still fall under the dealer classification. However, the list of factors used to determine dealer status is not set in stone and is a highly litigated area of tax law. Taxpayers should confer with their tax advisors and tax counsel to determine if they are considered a dealer.

Ordinary Versus Capital Gains Tax Rates

Ordinary Income Tax Rate: If the taxpayer is determined to be a “dealer,” the ordinary income tax rate will apply. Tax rates are different for individuals and businesses: for the 2022 tax year individual ordinary income tax rates are between 10% and 37% and business tax rates depend on the structure and entity classification of the business. For example, the corporate tax rate is currently 21%.

Capital Gains Tax Rate: If a property home flipper manages to avoid being classified as a dealer, they can take advantage of capital gains tax rates. There are two types of capital gains rates: short term and long term. The short-term capital gains rate is applicable to properly held for less than one year, and the applicable rate is the same as the ordinary income tax rate. On the other hand, the long-term capital gains rate is applicable to property held for one year or longer and ranges between 0% and 20% for tax year 2022.

Are There Ways to Lower Taxes on a House Flip?

Taxpayers can work to structure their business and transactions to take advantage of different opportunities to lower exposure to tax. Some examples include:

• If the taxpayer does not qualify as a dealer and holds the property for at least 12 months, they can utilize the long-term capital gains tax rate;
• Deduct all expenses related to the flipping of the property on your tax return. Some examples of deductible expenses include obtaining building permits, interest paid on mortgage(s) on the property, capital expenditures, office expenses, labor costs, equipment depreciation, insurance, vehicle expenses, etc;
• Structure the purchase or sale of the specific property with a like-kind exchange of another property (commonly referred to as a 1031 exchange);
• Review federal, state, and local tax regulations for any potential real estate development tax credits;
• Utilize certain business structures, such as a Corporation or S Corp, to lower your tax liability..

What’s Next?

Flipping houses can be rewarding work with high-profit margins. If you are interested in selling property just purchased as a flip property, there are several tax consequences that you need to be aware of. You may just be able to find a way to save significant funds by working to reduce or completely remove tax liability when flipping homes. Ensure your strategy on real estate investing is tax-advantaged. See how Corvee can help.