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.
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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.
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.
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% |
|
|
|
| 12% |
|
|
|
| 22% |
|
|
|
| 24% |
|
|
|
| 32% |
|
|
|
| 35% |
|
|
|
| 37% |
|
|
|
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.
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% |
|
|
|
|
| 15% |
|
|
|
|
| 20% |
|
|
|
|
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).
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: