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Clemmons, NC Office
3746 Clemmons Road.
P O Box 1396
Clemmons, NC 27012
336-766-6811
Mocksville, NC Office
151 South Main St.
Mocksville, NC 27028
336-753-1839
Littleton, CO Office
1767-A Denver West Blvd.
Golden, CO 80401
P O Box 620892
Littleton, CO 80162
303-913-3256 |
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| | | Flipping Houses or Real Estate Investing - The Tax Consequences
| | | | It is very important to understand the tax consequences of real estate investing or you could be in for a very unpleasant tax bite. If you are not buying a primary residence or second home, one of the first tax planning steps is to determine whether you are (or are planning to be) a real estate investor or a flipper. There are very different tax consequences and tax planning requirements associated with each. The Real Estate Investor
The investor holds real estate for long-term appreciation or investment purposes. The investor holds real estate for more than one year and is interested in maximizing the gain on investment and is not in the business of buying and selling property for short-term profit. One of the biggest tax advantages of being an investor is that any gain on a sale is taxed at a maximum of 15%. The real estate investor is also not normally subject to the 15.3% self-employment tax. However, the investor is limited to only $3,000 of losses per year on investments. The Flipper/Dealer
Someone who is in the business of flipping houses – buying houses, fixing them up, and then selling them for short-term gain - is considered to be a dealer by the IRS. The dealer holds real estate in the ordinary course of business and anticipates a very quick turnover and profit. The real estate dealer is taxed very differently from the investor. The dealer may be taxed at individual income tax rates up to 35% and may also be subject to 15.3% self employment taxes. Dealers cannot transfer property through a 1031 (like-kind) exchange, cannot use the installment sale method, and cannot take deductions for depreciation. There is one tax advantage to being a flipper - the dealer is not limited to $3,000 in tax losses per year. Flipper or Investor - The Tests
The most important factors used to make this call are the INTENT and PURPOSE of the property acquisition and holding. Some of the criteria used by the IRS and the courts to determine intent and purpose include: - Length of time the property is held - Normally an asset needs to be held for over one year to qualify for capital gains treatment. This is true of real estate, but this is not a definitive test. Just because property is held for over one year does not necessarily make it investment property.
- Number of properties sold in a year – There is no set number, but if you sell only one property in a year, you are probably not a dealer.
- Have a job outside of real estate – If your primary job is not related to real estate, you are probably an investor. If you are a real estate broker, real estate developer or associated with a real estate company, you are likely to be considered a dealer.
- Have employees who help you sell the properties – If you have employees who help you sell real estate, you are likely to be a dealer.
- Use a business office to sell properties – If you sell properties out of a business office, you are most likely a dealer.
- Time and effort in buying and selling – The more time you spend buying and selling properties, the more likely you are going to be classified as a dealer.
- Net profits received for the year – The higher your real estate-related profits, the more likely you are a dealer. This is particularly true if real estate profits are high in relation to other income you have earned.
- Extent of improvements made – The more improvements made, the more likely you are a flipper.
- Renting property – If you rent property, you are probably holding that property as an investment and not looking to sell it for short-term gain.
These are just some of the criteria used. The criteria and their application may seem vague and subjective. This is why it is extremely important to do some pre-tax planning and take the appropriate actions for your unique situation. Food For Thought - Flipper or Dealer - How to Tell the Difference
There are times when making the distinction is extremely difficult. Even the tax court seemed to throw up its hands in this item form the CPA Journal and quoted in Carl Zimmerman’s article, “Real Estate Dealer or Investor?” - “[t]he problem is so severe that, according to the Fifth Circuit Court of Appeals, ‘if a client asks you in any but an extreme case whether, in your opinion, his sale will result in capital gain, your answer should probably be, ‘I don’t know and no one else in town can tell you’’ (J.D. Byram, CA-5, 83-1 USTC para. 9381, 705 F. 2d 1418).” Give Us a Call
We will be happy to review your situation and help you take the appropriate actions to meet your financial goals.
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