Flipping Houses and Taxes

By Jeanette Joy Fisher  One question beginning real estate investors interested in flipping houses ask frequently is "Won't I lose all my profit in capital gains taxes?" Because I’m not a tax attorney or CPA, I advice investors to talk to a professional tax expert.   Many investors think they don't want to flip houses because they're afraid of the tax consequences. If you're paying income taxes, why do you expect a free ride making money investing in real estate?  Problems arise when real estate speculators don't follow the law. This is why you need professional advice. One trap, selling too many properties too quickly, could mean that the IRS could say that your real estate business is your trade, subject to ordinary income and self-employment taxes. Self-employment tax, a social security and Medicare tax primarily for individuals who work for themselves, is similar to the social security and Medicare taxes withheld from the pay of most wage earners. The self-employment tax rate costs you 15.3% of your profits. However, this does provide retirement benefits. Another common mistakes that beginning investors make is not holding the property long enough. To take advantage of the low 15% capital-gains tax rate, you must keep the investment property for at least a year before selling. If you sell before a year, your tax rate, the usual capital gains rate of 35%, could eat up a significant amount of your profits.  However, the Internal Revenue Code provides real estate investors away to defer capital gains taxes indefinitely. Section 1031 of the Internal Revenue Code provides a tax-free exchange. Also known as a "like-kind" exchange, this code allows you to sell a business or investment property and defer capital-gains taxes by immediately investing the gains into a similar piece of property. The key, replacing a business or investment with similar property, means that no gain gets paid to the investor. Any profit taken out of escrow gets taxed. This means that beginning investors may take out a portion of the profit after they carefully explore their tax liabilities. In other words, talk to an accountant and find out what your tax would be according to your current usual income. Many business owners take advantage of this because they have many deductions.  The big mistake beginning real estate investors make doing a 1031 tax-free exchange, taking possession of the profits, voids the deferred tax. To properly do a 1031, you must declare the sale of your property to be a part of a 1031 exchange before you sell the property. Then you have the money placed in a trust account held by an intermediary until you purchase the new investment property. You can't purchase a primary residence or a vacation home with funds from an investment property. You have 45 days to identify a replacement property and 180 days to close on the new investment. The best advice I can give beginning real estate investors: Talk to an accountant Would you be better off making extra money, even if you must pay taxes? ©2005 Jeanette J. Fisher. All rights reserved. You may not use this article without permission. Real Estate Investing Articles Bouncing on the Real Estate Bubble... How a newbie investor breaks in Creative real estate investors have been experiencing a boom over the last decade. They have been able to see some serious profits in a relatively short period of time. Some markets continue to show this amazing growth too. Areas like Phoenix, AZ and Las Vegas, NV are as hot as the desert that they are located in. Some people predict and end in sight very quickly, while others believe that it will continue. Real Estate Investing Business Plan Get all the tools you need to start your real estate investing business.

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