Flipping Houses Tax Considerations and Strategies

Purchasing a fixer-upper isn’t for the faint of heart. However, that didn’t stop house flippers across the US from updating over 300,000 properties in 2021

If you’ve considered buying an investment property that needs updates, you may be asking, “Is profit from selling a house taxable?” Or, if you simply want to increase earnings on your next property further, you may be asking something like, “How do house flippers avoid capital gains tax?” 

The truth is that you can’t get out of paying taxes on real estate profit. But, by understanding flipping houses tax and working closely with a tax professional, you can reduce what you owe and maximize your fix and flip profit.

Table of Contents:

Taxes on Flipping Houses: The Basics

A typical house flipping tax rule is that profits made are taxed like traditional income (active income) instead of capital gains (passive income). This is the case unless you’re classified as an investor – not a dealer – and you’ve owned the property for longer than a year.

The intent behind acquiring a property (i.e. whether you plan to develop the land immediately and then sell to different entities, or hold onto the land for a few years), the frequency of your purchases, and the amount of marketing and advertising you do can classify you as a dealer. 

Real estate dealers receive far fewer tax breaks. This includes the inability to benefit from 1031 exchanges, participate in installment sales, and claim depreciation on property. If you’re new to this type of real estate investing, talk with a financial or tax advisor before you purchase a fixer-upper and during the updating process. By doing so, they can help you avoid being classified as a real estate dealer.

Capital Gains on Flipping a House

Just by simply being termed a real estate investor instead of a dealer means you could save a great deal of money on flipping houses tax each year. However, even as an investor, those tax rates will change depending on how long you hold a given property.

Short-Term Capital Gains on Flipping a House

Profits made from buying, flipping, and selling a property in less than one year are subject to short-term capital gains tax. And, unfortunately for quick flippers, you’ll be taxed at your ordinary income tax rate, as shown in the table below.

Tax Rate

Individual taxable income

Married/filing jointly taxable income

Head of household taxable income

10%
  • $10,275 or less
  • $20,550 or less
  • $14,650 or less
12%
  • $10,276 – $41,775
  • $20,551 – $83,550
  • $14,651 – $55,900
22%
  • $41,776 – $89,075
  • $83,551 – $178,150
  • $55,901 – $89,050
24%
  • $89,076 – $170,050
  • $178,151 – $340,100
  • $89,051 – $170,050
32%
  • $170,051 – $215,950
  • $340,101 – $431,900
  • $170,051 – $215,950
35%
  • $215,951 – $539,900
  • $431,901 – $647,850
  • $215,951 – $539,900
37%
  • $539,901+
  • $647,851+
  • 539,901+

Source: Internal Revenue Service

While flipping a property and selling it in less than a year can provide some hefty monetary gains, you’ll be responsible to pay taxes on a large chunk of that profit. Aside from your typical income tax, you’ll also likely have to pay self-employment taxes at 15.3% in 2022.  Because of this, holding onto property for over a year can leave you with higher net earnings.

Long-Term Capital Gains on Flipping a House

If you hold your real estate investments for longer than one year, you’ll be subject to long-term capital gains tax and can save a significant amount of money each year on taxes. Review the following table to determine how much you may owe based on the return on investment of your fixer-upper. 

 

Tax Rate

Individual taxable income

Married filing separately taxable income

Married filing jointly taxable income

Head of household taxable income

0%
  • $0 – $40,400
  • $0 - $40,400
  • $0 – $80,800
  • $0 – $54,100
15%
  • $40,400 – $445,850
  • $40,400 - $250,800
  • $80,800 – $501,600
  • $54,100 – $473,750
20%
  • $445,851+
  • $250,801+
  • $ 501,601+
  • $ 473,751+

Source: Internal Revenue Service


The IRS has also outlined specific exceptions where you may be charged more than 20%, but the instances are few (and not all are related to real estate).

What Expenses Can I Deduct When Flipping a House?

There are a variety of deductions available to home flippers. Some are only applicable after you’ve sold the property, but you may be able to deduct other expenses before it’s been sold. Some of these deductions include:

  • Cost of home: Can potentially be deducted after selling the property.
  • Labor and materials: Keep a detailed cost breakdown as you move through the renovations to make it easier when looking for potential deductions.
  • Utilities: This typically includes the water and gas bills you pay as the property owner.
  • Commission to agent: If you used a real estate agent to help you find your property, you may be able to deduct said agent’s commission.
  • Real estate taxes: Talk with a tax professional to learn how much you can deduct based on what you pay in real estate tax.
  • Office expenses: If you need a designated space to conduct business related to the property, this may be eligible for some deductions. 
  • Mortgage interest: Depending on the terms of your loan, you may be able to deduct a portion of your interest. By financing with a trusted company that offers some of the most competitive rates (like Revolution Realty Capital), you can further increase your overall profit.

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To get a complete list of possible tax breaks, talk with a tax professional who can explain the more nuanced rules for each deduction.

Flipping Houses Tax Example

Calculating your potential flipping houses tax can seem overwhelming if you’ve never done it before. Look through the example below to get a better sense of how it works and what your taxes may look like in the future (assuming you’re filing as single or married filing separately). 

Short-Term Capital Gain

Long-Term Capital Gain

Flipping Houses Cost:

  • Purchase price: $60,000
  • Labor + materials: $40,000

Resale price: $140,00 

Total revenue: $40,000


Taxes: 

  • Property owner income tax rate: 24%
    • 40,000 x 24% = 9,600
  • Self employment tax rate: 15.3%
    • 40,000 x 15.3% = 6,120

Total Profit: $24,280 

($40,000 - $9,600 - $6,120)

Flipping Houses Cost: 

  • Purchase price: $60,000
  • Labor + materials: $40,000

Resale price: $140,000

Total revenue: $40,000


Taxes: 

  • Long-term capital gains rate: 0%




Total Profit: $40,000

 

As you can see, there can be large rewards for being classified as a real estate investor and holding a property for longer than a year. Real estate dealers can also receive a greater profit with deductions and other exclusions as well.

IRS Publication for Flipping Houses

Between gathering all of your relevant financial information and determining which forms you need to fill out, tax season can be a headache if you’re not prepared. Look through the different IRS tax forms and publications below to get a better sense of which may apply to you. 

  • Schedule C (Form 1040): If you’re an LLC or real estate is your profession (in other words, if you’re classified as a real estate dealer), fill this form out to record profit and loss from the year’s activities. 
  • Schedule D (Form 1040): This form is to report the sale of a capital asset. If you’re classified as a real estate investor, you’ll use this form to report gains or losses from fix and flips and any other real estate ventures. 
  • Schedule E (Form 1040): If you’re registered as an S Corporation, you’ll use this form to fill out your business’s profit and losses for the year (as an S Corporation you’ll be subject to the typical income tax, but won’t have to pay self-employment tax). 
  • Section 121 Exclusion: If your fixer-upper was your primary residence for at least two of the five years before you sold it, you can exclude up to $250,000 (or $500,000 if filing a joint return with a spouse) of any gains attained once sold.
  • 1031 Exchange: If you opt to reinvest your fix and flip gains into a similar property, you can defer paying taxes on those gains until a later date. However, keep in mind that the 1031 exchange makes your gains tax-deferred, not tax-free.

While understanding how to report flipping a house on your tax return (and all of the nuances associated) can be beneficial, you don’t have to learn everything all at once. Talk with other flippers who have successfully reduced the amount of taxes they owe as well as tax professionals who can help you through the process from start to finish. 

Most of all, don’t let flipping houses tax stop you from further diversifying your portfolio. If you’re ready to maximize your profit even further, contact Revolution Realty today to secure a fix and flip loan with a competitive rate and quick closing period.

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