Flipping a new property?
A key part of the fix and flip process is estimating costs and expenses, and this includes taxes. Fix and flips have specific tax structures associated, and this type of investing is considered to be active investing by the IRS. This “active investing” label means that any profits gained from the project are classified as active income.
An active income classification means that there are various taxation rates, deductions and other details applied to the investing process, and real estate investors will need to have a good hold on their financial records and stay on top of their expenses to reap the full benefits.
This is what you need to know about taxes when flipping your next property:
Type of Income
Real estate investors completing multiple real estate transactions per year can expect CPAs to consider their investments a business, which could lead to higher income taxes. The IRS often considers fix and flippers to be “real estate dealers or traders”, individuals who purchase and sell property over shorter terms in the course of their business and will tax them as such.
This classification sees the profits from fix and flips categorized under the regular income tax rates.
The tax brackets for this type of investment can fall between 10 and 37%, depending on where the property is located, and other influencing factors. These classifications will also apply to real estate investors flipping their first property, making it essential to understand local tax applications and their impact on the property’s costs and pricing. For those running a real estate business as a partnership or limited liability company, should put an operating partnership agreement in place which specifies that the investments held will appreciate in value.
The income that these “real estate traders” can earn from house flipping is considered active income, subject to ordinary income tax rates, including another 15% in self-employment taxes.
Fix and flippers working on a property but able to avoid classification as a real estate dealer can find themselves taxed at lower capital gains rates based on the profits made by selling the property in question.
Classification as a real estate dealer on the other hand, can really heighten the range of the tax consequences. Avoiding the classification as a dealer is rare, but not unheard of in previous years. It is also important to note that flippers who can qualify for capital gains tax treatments typically do not have to pay self-employment tax.
Short-term vs Long-term Capital Gains
The profit an investor generates from the sale of a property is considered to be a capital gain.
Shorter-term capital gains are taxed based on normal income tax rates, but when a property is held for more than a year, and without classification as a dealer, profits will be taxed based on long-term capital gains rates.
For the majority of taxpayers, the above rates will range between zero to twenty percent. When compared to having to pay income tax and self-employment tax, there can be more savings in longer term capital gains.
Saving Money With Deductions
There are some real estate tax advantages that investors can benefit from, if they are aware of these advantages when starting out. Many of the costs associated with renovation and labor on the property can be deducted, but this is often overlooked by new real estate investors who are still unfamiliar with the local tax structures. Real estate investors with home offices can also deduct these spaces.
Other potential deductions can include travel expenses such as going to and from the property, certain settlements and the mortgage interest from bridge loans are only a few examples.
There are also deductions available in the form of tax codes which favor landlords or rental owners, minimizing tax liability. Managing your fix and flip expenses is key to reducing the amount of income which is taxable, so it is key for real estate investors to keep a keen eye on all the ins and outs here, no matter how insignificant the expense may seem. Managing expenses and saving costs through deductions are some of the benefits that real estate investors can reap.
Taxes are a natural part of real estate investment, and it is important for property flippers to know some of these basic tips when actively investing. For fix and flip investors, the importance given to investing in a great property should also be given to good financial recordkeeping. By being more familiar with the way fix and flip investors are taxed, it becomes possible to know which deductions can be made to maximize savings.