Flipping Houses and Taxes – Everything You Need to Know

Unfortunately, paying taxes are part of every aspect of our lives, and flipping houses is no exception. 

And because flipping houses and taxes go hand in hand it’s important to know everything you can about the type of taxes you might pay as well as the best ways to limit tax exposure when flipping houses.

Flipping Houses and Taxes

How you flip a house can greatly impact how much and what type of tax you pay when flipping houses.  Below are some common scenarios when it comes to flipping houses and how taxes can be affected.

Remember that these are just general house flipping examples and not tax or legal advice.  Before making any financial decisions always consult a local professional.

House Flipping Scenario 1

One of the most popular and common ways to flip a house is as an individual.  Flipping a house as an individual means you buy the house, work on the house, and sell the house in your own name.

Flipping houses as an individual is the simplest way to flip a house.  However just because this is the simplest way does not necessarily mean it’s the best way to flip a house especially when it comes to taxes.

Profits as an individual house flipper will typically be taxed at the short-term capital gains rate which is the individual’s earned income tax rate.  While flipping a house as an individual is an easy and straightforward approach to house flipping.  There is another way to flip houses that can potentially reduce your tax liability when house flipping.

House Flipping Scenario 2

If you plan to start a house flipping business it can make sense to form a corporation to flip properties in.  In this scenario, you would purchase and sell the property in your corporation’s name and work on the house as an employee of your corporation.

Flipping houses inside of a corporation can greatly reduce the tax liability when flipping houses.

Flipping Houses Through a Corporation and Taxes

When a corporation owns the property any profits made will pass through the corporation before being taxed at an individual level.  This is advantageous because of something called write-offs.  Corporations use write-offs to deduct appropriate business expenses from profits before they are taxed.

For example, suppose a house flipper who flips properties in a corporation, flipped two properties and had a profit of $50,000 for the year.  Before the house flipper was taxed on the profits he would write-off legitimate business expenses, that let us say totaled $10,000 for the year, thereby reducing his taxable income to $40,000.  Meaning instead of paying taxes on $50,000 he would pay taxes on only $40,000.

Not only do house flippers who use a corporation benefit from write-offs come tax time, but they can also potentially benefit from something called disbursements. 

Using the same scenario as above, this house flipper with the help of an accountant could choose to break apart the profits from the business into two separate categories.  Where $25,000 of the profits is treated as earned income and the other $25,000 is treated as disbursement income.

Separating the profits into earned income and disbursement income can be advantageous because typically less tax will be paid on disbursement income.

Best Way to Flip a House for Tax Purposes

Flipping houses inside of a corporation doesn’t always make sense though especially if you are going to just flip one or two houses.  Because in order to flip houses inside of a corporation you have to first set one up and also maintain one which usually requires assistance from an accountant and or an attorney.  In addition, an accountant will typically charge more to do corporate taxes as opposed to individual taxes because they are more complicated and can require more work.

So it’s important to consult with a local professional and to weigh all your options before deciding on the best course of action for your house flipping endeavors.

How to Reduce and Avoid Taxes When Flipping Houses

There are a few different ways to reduce taxes when flipping houses.  Below is a list of some of the more common methods to reduce or avoid paying taxes when house flipping.

Hold the Property for More Than a Year

If you’re going to invest in real estate it’s important to understand the difference between short-term and long-term capital gains.

Short-term capital gains is the tax rate paid on any profits received from an investment held for less than a year and is typically taxed at the individuals prevailing earned income tax rate for the year.

Whereas long-term capital gains is the tax rate paid on any profits received from an investment held for more than a year and is taxed at either 0, 15, or 20% depending on the individual’s taxable income for the year.

Less tax is typically paid on the long-term capital gains as opposed to short-term.  So when flipping houses if you hold the property for longer than a year you can reduce your tax bill when you go to sell the property.

Live in the Home as a Primary Residence

How does paying nothing on the profits from your house flip sound?  As incredible as it is, owing no capital gains tax and paying 0% on the proceeds from a house flip is actually possible.

This is because the IRS allows a $250,000 or $500,000 exemption depending on whether you are single or married filing jointly on the proceeds from the sale of your home.

In order to be eligible for this tax exemption, there are three criteria that you must meet to qualify.

• You must have owned the home for at least two years during the five years prior to the date of your sale. It doesn’t have to be continuous, nor does it have to be the two years immediately preceding the sale.
• You must have used the home you are selling as your principal residence for at least two of the five years prior to the date of sale.
• Finally, you have not excluded the gain on the sale of another home within two years prior to this sale.

While this obviously won’t work for every house you flip this can be a great way to avoid paying capital gains tax on a flip when you have met the above criteria.

Flip Houses Through a Corporation

As detailed above one of the best ways to consistently save and reduce taxes from flipping houses is by flipping houses through a corporation.  By flipping houses through a corporation you will be able to take advantage of corporate tax breaks when house flipping.

Want to learn more about flipping houses as a business?  Check out our article “Flipping Houses as a Business 101“.