In last week’s blog we discussed the income opportunities to be had when it comes to short-term rental properties such as Airbnb or VRBO. This week we are highlighting another income opportunity within real estate investing and that is flipping houses. Whatever you decide to invest in - whether it be long-term rentals, short-term rentals, or flipping houses - you must always be aware of the unique tax implications.
As discussed last week, short-term rental income is reported on either Schedule E or Schedule C if actively involved (i.e., maid service, regular cleaning, meals, or other substantial services). With flipping houses, the profit you earn is typically considered ordinary income and reported on Schedule C and subject to self employment tax (SE tax). An important distinction to be made between house flippers and those that hold real estate for short-term or long-term rentals, is that house flippers are likely to be considered “dealers” by the IRS. There are always exceptions to any rule so we suggest working with a CPA to ensure you understand the tax implications of your specific situation. If you are curious about flipping houses and want to minimize tax, there are options to consider.
Can you move in?
If you’re willing to hold your property for a longer period of time, you might consider moving in yourself. If you’re flipping a single property, you could make it your primary residence until it is sold. You’d need to be in possession of the house for more than a year in order for capital gains to apply - so this strategy might not be suitable depending on your overall investing plan. If this is an option, the profit from the final sale would be subject to capital gains tax which is a lower rate than the ordinary income tax rate and SE tax. If you can live in the home for at least two years, you may be able to exclude some or all of the gain from taxable income under Sec 121 Exclusion of Gain From Sale of Personal Residence.
Can you rent out?
Maybe it’s not in the cards for you to move into a flip but perhaps you can rent it out. The rental income that you earn will likely be reported on Schedule E and not subject to SE tax. When you decide to sell, you will then be subject to capital gains tax.
Can you be taxed as an S Corp?
If you’re hoping to turn flipping homes into your full-time occupation, it might be worth considering making an S-Corp election. With the strategy, you can split your income between a reasonable salary and a distribution. You will still have to pay SE tax but only on the salary and not distributions.
These are examples only and not meant to be an all comprehensive list. As mentioned earlier, there are always exceptions and it’s important to establish a relationship with a CPA that can help you to build a strong strategy. Flipping houses isn’t for everyone but if you are willing to invest the time, make the right connections, and put your self-improvement skills to the test, it can lead to a profitable outcome.
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