Taxes On Flipping Houses & How To Avoid Them (2023-2024)

This comprehensive guide aims to provide clarity on the taxes on flipping houses, offering insights into the basics, effective tax strategies, how to get the most deductions, and ultimately clarifying any complex questions to better help with your financial goals.

Navigate to your preferred section, here:

• The Basics Of House Flipping Taxes

• Is Flipping Houses Tax-Free?

• How Much Are Taxes On Flipping Houses?

• Capital Gains Tax On Flipping A House

• Flipping Houses & Self-Employment Tax

• How To Avoid Capital Gains Tax On House Flipping

• Tax Deductions For Flipping Houses

• When Are House Flipping Taxes Paid?

• How To Calculate Taxes On Flipping Houses (Step-by-Step)

• House Flipping Tax Calculation Example

House flipping has evolved into a viable business model for many real estate investors. However, navigating the tax implications of flipping houses is crucial for anyone considering this venture. Understanding the nuances of taxes associated with house flipping is key to ensuring that unforeseen tax liabilities don't significantly diminish your potential profits.

House flipping typically involves purchasing a property—often one that's distressed or undervalued—investing in necessary renovations, and reselling it at a higher market value. Like any business venture, flipping houses attracts certain taxes, which vary based on factors like the duration of property ownership and the nature of the investment.

While house flipping can be lucrative, it's essential to approach it with a thorough understanding of the financial and tax aspects involved.

Whether you're a seasoned investor or just starting out, grasping the tax dynamics of house flipping is a critical step toward a successful and profitable real estate investment.

 

Let’s Start With The Basics Of House Flipping Taxes

Understanding the basics is crucial, especially if you're new to real estate. Here's a simple breakdown of how taxes work on house flipping:

• Active Income: The money you make from flipping houses is usually seen as active income by the IRS. This means you pay regular income taxes on your profit, just like you would for a typical job. This includes federal and state income taxes, plus self-employment taxes.

• Dealer Status: Most house flippers are considered dealers by the IRS. This label is given even if flipping houses isn't your full-time job. It basically means you're buying properties to quickly sell them for a profit.

• Ordinary Income vs. Capital Gains: Generally, the money you make from flipping is taxed as ordinary income, regardless of how long you hold onto a property. But if you keep a property for more than a year, it might fall under capital gains tax, which can be up to 20%. Capital gains tax is usually for long-term investments like rentals or your primary home, but it can sometimes apply to flips too. The good part? If you're paying capital gains tax, you don't have to pay self-employment tax on that income.

• Short-term vs. Long-term Gains: There are two kinds of capital gains taxes – short-term (for properties sold in less than a year) and long-term (for properties sold after a year). The type depends on how quickly you sell the property after buying it.

• Business Classification: The IRS can consider your house flipping as a business, even if it's just part-time or alongside another job. This means your real estate activities are taxed like any other business.

Remember, taxes can get complicated, so it's always a good idea to talk to a tax professional for advice specific to your situation.

If you are a new investor or veteran house flipper and want to learn more, we invite you to attend our brand-new FREE training course on house flipping, wholesaling, and real estate investing. Sign up today and get 24/7 support and expert training for your real estate ventures!

Read Also: 5 Best Places & Cities To Flip Houses

 

Is Flipping Houses Tax-Free?

No, flipping houses is not tax-free. If you choose to get involved in flipping homes as a source of income, you need to understand the tax implications of flipping a house.

In general, flipping houses is treated as income for the person or entity that is “flipping” the home.

For example, one main difference between people versus entities is the amount of taxes to be paid when flipping homes.

In general, corporations pay less than individuals in taxes, so to avoid paying massive amounts in taxes on the income of flipping properties, the best practice is to sell as a legal entity like a limited liability company (LLC) rather than as an individual.

There are plenty of ways to learn about taxes on flipping a house. Review these common IRS and forms for flipping houses from H&R Block tax experts:

• Schedule C (Form 1040): If you’re self-employed and set up your business as a sole proprietorship, you should file Schedule C with your Form 1040 to report the profit or loss for your business.

• Schedule D (Form 1040): Tax schedule from the IRS that attaches to Form 1040, U.S. Individual Income Tax Return, Form 1040-SR, or Form 1040NR. Schedule D (Form 1040) is used to help you calculate their capital gains or losses, and the amount of taxes owed.

Read Also: Do You Need A Real Estate License To Flip Houses?

 

Exactly How Much Are Taxes On Flipping Houses?

Calculating the exact amount of taxes payable when flipping houses depends on various factors, including your income tax rate, federal tax bracket, and the duration of property ownership.

For 2023, the federal income tax brackets have been adjusted, impacting how much house flippers might owe in taxes. Key points house flippers should consider are:

• Federal Income Tax Brackets (2023): Tax rates range from 10% to 37%, with brackets adjusted for inflation. For instance, singles earning up to $11,000 fall into the 10% bracket, while those earning over $578,126 are taxed at 37%. Similar adjustments apply to other filing statuses like married filing jointly, married filing separately, and head of household.

• Duration of Property Ownership: The time you hold the property significantly affects tax rates. Properties sold within a year of purchase are subject to ordinary income tax rates, aligning with your tax bracket. Conversely, primary residences or properties held for over a year qualify for long-term capital gains tax, ranging between 0% and 20%, based on your income bracket.

• Self-Employment Tax: Flipping houses typically incur a self-employment tax rate of 15.3% on net profits, up to a certain threshold.

• State Income Taxes: Additionally, state taxes based on specific state income tax brackets must also be considered.

 

Capital Gains Tax On Flipping A House

When calculating taxes on house flipping, understanding the implications of capital gains tax is essential. Typically, real estate is regarded as a capital asset, and profits from the sale of a home may qualify for capital gain tax rates. However, for those engaged in the business of flipping houses, the tax scenario differs significantly.

Flipping a house usually falls under the category of short-term capital gains. If a flipped property is bought and sold within a year, the profits are taxed at the same rate as regular income tax. This approach aligns with the business model of house flipping, where the goal is to renovate and sell the property swiftly, often to avoid the costs associated with holding the property.

In contrast, long-term capital gains tax, applicable to assets held for more than a year, typically offers more favorable rates, ranging from 0% to 20%, based on the income bracket. However, most house flippers don’t benefit from this lower rate due to the short-term nature of their investments.

It’s important to note that the IRS categorizes individuals who frequently buy and remodel real estate for profit as dealers, not investors. In these cases, the real estate is considered inventory rather than capital assets, and profits are treated as ordinary income, subject to self-employment tax. This classification has significant tax implications, differing from the typical capital gains rules that apply to ordinary real estate investments.

The capital gains tax on flipping houses largely depends on the duration of the investment and the frequency of such transactions. Understanding these distinctions and planning accordingly is crucial for anyone involved in house flipping to manage their tax liabilities effectively.

Read Also: Tax On Rental Income: How Much To Pay & More

 

Capital Gains Tax Rates For 2023

The capital gains tax rates for 2023 are tiered, based on the asset sold and the individual's taxable income. These rates are structured as 0%, 15%, 20%, 25%, or 28%, offering varying tax implications for different income levels and types of assets.

The majority of net capital gains are subject to a maximum tax rate of 15% for most taxpayers. If your taxable income falls below certain thresholds — $41,675 for single filers, $83,350 for married couples filing jointly, $55,800 for heads of households, or $258,600 for married filing separately — a portion or all of your net capital gain may be taxed at a 0% rate.

For taxable incomes exceeding these lower thresholds but remaining within the following limits — $459,750 for single filers, $517,200 for married filing jointly, $488,500 for heads of households, or $258,600 for married filing separately — the capital gains tax rate is 15%. However, for taxable incomes surpassing these limits, a 20% tax rate applies to net capital gains.

Certain exceptions apply where capital gains could be taxed at rates higher than 20%. For instance:

Gains from selling qualified small business stock under section 1202 are taxed at a maximum rate of 28%.

Capital gains from selling collectibles like art or coins can also be taxed at a maximum rate of 28%.

Unrecaptured section 1250 gains from selling section 1250 real property are taxed at a maximum rate of 25%.

Understanding these capital gains tax rates for 2023 is crucial for real estate investors, particularly house flippers, to accurately assess their potential tax liabilities and plan their investments accordingly.

 

Is Flipping Houses Subject To Self-Employment Tax?

Investors who profit off flipping houses are subject to self-employment tax rates of 15.3%, effective federal tax rate of 20%, and state income tax rate of 5%. However, creative tax solutions can help ease the burden of self-employment taxes.

If you are a sole proprietor in your business, you pay the SE tax rate as established by the IRS. However, if you elect to be a legal tax entity such as an LLC, you can choose to pay yourself a reasonable salary and claim disbursements on the remainder of your profits.

You establish an LLC for tax purposes of your house flipping business and choose to pay out as an S Corporation (S Corp). This designation allows you to pay yourself a reasonable salary from your profits and then pay out the remainder as disbursements, lowering your self-employment tax burden.

One caveat to this strategy is that the IRS expects the amount of self-employment salary to be reasonable (In other words, you cannot just claim $1.00 as your salary).

Read Also: Wholesaling Real Estate Taxes: (Ultimate) Guide For Investors

 

How To Avoid Capital Gains Tax On House Flipping (2023)

You cannot avoid capital gains taxes on house flipping entirely, but there are strategies to significantly reduce the tax burden.

While it's crucial to comply with tax obligations, understanding and utilizing available tax strategies can optimize your financial outcome. Here are the tax strategies you can use to reduce your home flipping tax:

• Establishing An LLC
• Managing The Duration Of Property Ownership
• 121 Exclusion 
• Managing The Property Sale Date
• 1031 Exchange (Not Applicable For Quick Sales)

 

Establishing An LLC

One effective method is establishing a legal entity, such as an LLC, to manage your flipping business. This can allow for taxation at a corporate rate, which might be more favorable than individual tax rates.

Additionally, operating through a legal entity can provide other benefits like liability protection.

 

Managing The Duration Of Property Ownership

Another strategy involves the duration of property ownership. A primary residence or a property held for more than a year shifts its classification to a long-term asset.

This is significant because the IRS taxes profits on assets sold within a year at a higher rate compared to those sold after a year, falling under long-term capital gains.

This difference in tax rates can amount to substantial savings.

 

Can A 121 Exclusion Avoid Taxes On Flipping Houses?

The 121 exclusion is a provision in the tax code that allows for homeownership deductions up to $250,000.

To qualify, homeowners must possess and live in the property for 2 years within a 5-year window, meaning you can rent your home for up to 3 years, live and use the house, and claim up to $250,000 as exemptions.

Combined with long-term capital gains rates, this exemption can make long-term flipping an excellent investment opportunity and lower the overall taxes for house flippers as a result.

 

Managing The Property Sale Date

Managing the holding period and sale date of a property can play a pivotal role in minimizing the tax liability in house flipping. By controlling when the title and possession of the property are transferred, you can potentially align the sale with a year when your overall tax burden is lower.

This tactic can be particularly effective if you anticipate a year with lower taxable income. According to Investopedia, if your taxable income, including the gain from the property sale, falls below specific thresholds — $41,675 for single filers, $83,350 for married filing jointly, or $55,800 for head of household — you might qualify for a 0% tax rate on your capital gains.

However, if you expect consistent income levels where avoiding capital gains tax seems unfeasible, considering alternatives like the IRC Section 1031 exchange can be beneficial.

This exchange allows deferring capital gains tax by reinvesting the profits into another similar property, effectively delaying the tax implications.

 

Can A 1031 Exchange Avoid Taxes On Flipping Houses?

The 1031 Exchange, named after Section 1031 of the IRS Code, is a strategic tool for real estate investors to defer capital gains taxes; however, it's important to note that the 1031 Exchange is predominantly applicable to properties held for investment purposes and NOT typically for properties flipped for immediate profits.

This provision allows investors to reinvest the proceeds from the sale of an investment property into another like-kind property, effectively postponing the tax liability that would otherwise be incurred.

The truth is, if your business is considered to be “flipping real estate,” you cannot avoid taxation if you roll the gains of the sale into another house flipping investment.

A 1031 exchange is particularly advantageous for serial investors who continuously reinvest in new properties, as it can significantly enhance the growth of their investment portfolio.

 

Tax Deductions For Flipping Houses: Maximize Your House Flipping Tax Benefits

Flipping houses involves significant expenses, and understanding tax deductions is crucial for real estate investors.

Again, operating as a legal entity, such as a Limited Liability Company (LLC), can open doors to substantial tax deductions, ultimately impacting the profitability of your flipping projects.

Key tax deductions applicable to house flipping include:

• Purchase Price of the Home: The initial cost of acquiring the property.

• Material Costs: All expenses related to building materials used in renovation.

• Mortgage Interest: Interest on loans taken out to purchase or improve the property.

• Labor Costs: Both direct labor (contractors, tradespeople) and indirect labor (administrative support).

• Utilities: Costs incurred for utilities during the renovation phase.

• Rent Before Sale: Rent paid for the property during periods it's not under renovation or sale.

• Depreciation on Equipment: Reduction in the value of equipment used for renovations over time.

• Real Estate Taxes: Taxes allocated to the property during the renovation and holding period.

• Other Business-Related Expenses: This can include travel, office supplies, off-site office expenses, legal and accounting fees, and real estate commissions.

 

Considering Capitalized Costs

It's important to note that while some expenses can be deducted in the year they are incurred, others need to be capitalized.

Capitalized costs are added to the basis (original value) of the residence and provide a tax benefit when the property is sold, as the taxable gain is reduced by the amount of basis in the property.

 

Consult A Tax Professional For Accurate Deductions

Tax deductions for house flipping can be complex, and it is advisable to consult a tax professional specializing in real estate.

They can provide guidance on specific expenses that are deductible, how to capitalize costs effectively, and how to report flipping activities on tax returns.

An experienced tax advisor can help you make the most of these deductions, ensuring compliance with tax laws while maximizing your business's financial efficiency.

Read

 

When Are House Flipping Taxes Paid?

Here's a simple guide on when you need to pay taxes for house flipping:

• Taxes Post-Sale: You only owe taxes after you've sold a flipped property. Think of the property as "inventory." If you buy a house in one year but sell it the next, you pay taxes in the year you sell it.

• Quarterly Payments: As a house flipper, you're considered a business or self-employed. This means if you're making more than $1,000 a year from flipping, you need to make estimated tax payments every quarter. These are like advance payments on your expected tax bill.

• Filing Timeline: You'll file these estimated taxes four times a year – in January, April, June, and September. Use the Schedule C form (or 1040 Profit & Loss Form) for this.

• End-of-Year Filing: If you're not making any profit yet, you don't have to worry about quarterly payments. Instead, you'll file your taxes at the end of the year, just like most people do.

Remember, these tax payments are based on your estimated earnings from house flipping. It's important to keep track of your income and expenses throughout the year to make accurate payments.

If this sounds overwhelming, consider signing for our FREE training course on real estate investing including house flipping and wholesaling! Our experts are ready to guide you every step of the way!

 

How To Calculate Taxes On Flipping Houses (Step-by-Step)

When calculating taxes for house flipping, follow these steps provided by our real estate experts:

1. Determine Profitability

2. Identify the Type of Gain

3. Calculate Taxable Profit

4. Apply the Tax Rate

5. Consider Holding Period & Market Conditions

6. Final Calculation

7. Consult a Tax Professional

 

1. Determine Profitability

First, understand the 70% rule in house flipping. This rule helps estimate the investment needed and the potential return. It's calculated as:

After Repair Value (ARV) x 70% - Repair Costs = Maximum Allowable Offer (MAO)

Your expected profit will guide your tax strategy, based on market trends and projected return.

Read Also: What Is ARV In Real Estate? A Guide To After-Repair-Value

 

2. Identify the Type of Gain

• Short-term Capital Gains: If you sell the property within a year of purchase, it's considered short-term. Profits are taxed at your standard income tax rate.
• Long-term Capital Gains: If you sell after holding the property for more than a year, it's long-term. These gains are taxed at a lower rate.

 

3. Calculate Taxable Profit

Subtract total expenses and deductions from the final sales price. Common expenses include loan fees, repayments, professional services, materials, and labor.

The net profit is the amount remaining after all expenses are accounted for.

 

4. Apply the Tax Rate

Multiply profit by your tax rate. Use your ordinary income tax rate to your taxable profit for short-term gains. For long-term gains, use the capital gains tax rate, which may vary from 0% to 20%, depending on your tax bracket.

 

5. Consider Holding Period & Market Conditions

Decide on the optimal selling time based on market conditions and tax implications.

Then, choose a selling strategy. Weigh the benefits of short-term versus long-term holding for maximizing profits and minimizing taxes.

 

6. Final Calculation

Finally, bring it all together! Use the above steps to estimate your tax liability, considering both your selling strategy and the IRS rules on capital gains.

 

7. Consult A Tax Professional

For accuracy and compliance, seek advice from a tax professional, especially to navigate complex tax situations and maximize deductions.

By following these steps, you can effectively estimate your tax liability from house flipping, ensuring you're prepared for tax season and maximizing your investment's profitability. Remember, tax strategies should be a part of your initial investment planning to optimize returns and comply with tax regulations.

 

An Example Of House Flipping Tax Calculation

Now, let’s go over a simple example of the steps above. Imagine a scenario where you, a real estate investor, embark on a house flipping venture.

You purchase a distressed property for $200,000 and invest an additional $50,000 in renovations and improvements.

After a successful marketing campaign, you sell the property for $300,000. This results in a substantial profit of $50,000, which now needs to be evaluated for tax implications.

 

House Flip Details

• Original Purchase Price: $200,000

• Renovation Expenses: $50,000

• Resale Price: $300,000

• Total Profit: $50,000

 

Example Of Tax Calculation

1. Profitability Assessment:

   • After Repair Value (ARV): $300,000

   • Maximum Allowable Offer: $300,000 x 70% - $50,000 = $160,000

2. Type of Gain:

   • The property is flipped within a year, constituting a short-term capital gain.

3. Apply Federal Income Tax Rate:

   • Assume the investor is in the 24% tax bracket.

   • Federal Income Tax: $50,000 x 24% = $12,000

4. Self-Employment Tax:

   • Rate for 2023: 15.3%

   • Calculation: $50,000 x 15.3% = $7,650

5. State Income Tax (at 5%):

   • Calculation: $50,000 x 5% = $2,500

6. Total Tax Liability:

   • Federal Income Tax: $12,000

   • Self-Employment Tax: $7,650

   • State Income Tax: $2,500

   • Total Tax Due: $22,150

7. Net Profit After Tax:

   • Initial Profit: $50,000

   • Total Tax: $22,150

   • Net Profit After Tax: $50,000 - $22,150 = $27,850

 

Final Thoughts

Understanding the taxes on house flipping is crucial for anyone involved in this profitable yet complex real estate venture. The taxes on flipping houses in 2023 encompass various aspects, from capital gains tax, self-employment tax, to potential deductions and strategic maneuvers like the 1031 Exchange. Knowledge of these tax intricacies can significantly impact the profitability of your house flipping business.

Whether you're a seasoned investor or a newcomer to the world of real estate, grasping the tax dynamics of house flipping is essential. It's about aligning your investment strategy with smart tax planning to optimize your returns. Remember, each flip comes with its unique financial footprint, and the way you navigate these tax waters can make a considerable difference in your bottom line.

For those looking to delve deeper into the world of house flipping and learn the ropes of navigating these tax nuances, Real Estate Skills offers a free training course. Our course is tailored to equip you with the necessary skills and knowledge to thrive in the ever-evolving real estate market. Whether it's finding lucrative deals, understanding market trends, or mastering the tax aspects of house flipping, our comprehensive training has got you covered.

Join our free training course today and take your first step towards mastering the art of house flipping and optimizing your real estate investments in 2023.