With the residential real estate market stabilized and in many places, showing signs of robust recovery that’s supportive of so-called “house flipping” strategies of buying, renovating & selling a house for a profit, we’d like to remind our readers of the potential tax pitfalls that flippers have historically encountered:
1) The gain on sale of home exclusion rules DO NOT APPLY. Buying, renovating and selling investment properties do qualify for the home sale exclusion rules.
2) Is home flipping your trade or business? Because if it is, the IRS will want to assess self employment taxes of 15.3% on any income it determines is self employment income. If you take the position that home flipping is NOT your trade or business, be ready to defend that position. Factors such as your primary occupation, hours spent in your home flipping enterprise, the number of homes bought and sold in a given year, among many other considerations, should be carefully considered.
3) If you report the gain on home sales as a capital gain, whether short term (less than 1 year holding period) or long term (greater than 1 year). Holding onto a property longer than one year to trigger lower long term capital gains treatment may make “tax sense,” but missing out on a spring/summer real estate sales cycle, or taking the risks of a market correction or a change in the availability of mortgage financing to potential buyers may not make economic sense. Of course, any capital gain income may also trigger the so-called Obama investment income tax surcharge.
4) Like kind exchanges (Sec. 1031) can help defer (delay) the tax bill, but not eliminate the tax bill entirely. These exchanges can be complicated, though advantageous.
Tax treatment of home flipping profits is a technical and complicated issue filled with many gray areas. Consult a tax professional and keep good books and records to be safe.