We all love HGTV, don’t we? Whether it is Property Brothers, Flip or Flop, Love It or List It, or any number of television shows about flipping houses, it is the kind of reality TV show that makes us feel refreshed. An old house gets new life; a young couple renovates their way to a dream home; the worst house on the block becomes the best house on the block. It is truly the stuff of optimism bordering on a fairy tale.
Indeed, many people – may be even you – have been inspired to get into the house-flipping, or real estate investment, game because of those shows. Without question, house flipping is an engaging, challenging, and rewarding endeavor. It combines many of the things we enjoy, like decorating, fixing things, working with our hands, running our own businesses, and making money – maybe lots of it.
The thing to remember, however, is that not every house flipping experience gets wrapped up in 42 minutes (with a few commercials) and there are a lot of nuts and bolts that you need to consider if you open an LLC and decide to flip houses.
In this article, we are going to talk about one of the most important things that you must keep in mind with regard to your house flipping business – taxes. The tax attorneys of West Palm Beach at Doane & Doane have helped many clients who were happily engaged in the real estate investment industry. Yet, as we have assisted our house-flipping clients, we have seen a lot of confusion specifically surrounding the taxes of those who flip houses for a profit.
So, if you are ready to renovate, read on to learn some tax tips on how to keep your flipping business from being a flop.
1. Capital Gains
Oftentimes, the property is considered a capital asset. Therefore, the sale of a home may qualify for certain types of preferential capital gain tax rates. The rates get even better if your home qualifies as your primary residence. Also, if you live in the home for more than two years during the five years after you purchased the home, then you may be able to exclude the gain from taxation altogether, given certain special rules for homeowners.
That said, if you are in the business of flipping houses for profit, you may not be able to benefit from those preferential capital gains tax rates. The Internal Revenue Service (IRS) normally classifies those who actively purchase and remodel homes for profit on a continuing basis as “dealers” rather than people investing long term in a piece of real estate.
With that classification, the properties in question are viewed as “inventory” in your business rather than capital assets. The profits realized when you flip a house is considered ordinary income, which would be subject to self-employment tax.
2. Rolling Your Proceeds – Can You Avoid Tax?
The answer to that question is “no.” A lot of our clients who flip houses are under the erroneous belief that if they take the profits from one flip and roll it into purchasing another home then they can somehow avoid being taxed on those profits.
Unfortunately, the profit you make on a flip is reportable income if you are in the trade or business of flipping houses.
3. Tax Deductions
The business of flipping houses involves many expenses. Accordingly, you may think that you can lower your tax burden by immediately deducting those expenses.
Typically, however, your business can not immediately deduct the expenses. Rather, the expenses must be added into (or capitalized) the original value (or basis) of the residence. Those expenses (i.e., capitalized costs) will include:
- The cost of the home
- Renovation materials
- Renovation labor
- Indirect labor
- Equipment depreciation
- Insurance; and
- Real estate taxes
Remember, the profit you make on a flip is not just the difference between the original purchase price and the price at which you sold the house. That number is reduced by the amount of money you paid to renovate. So, your overall profit number will decrease, which decreases your tax burden. Ultimately, the expenses will help ease the taxes you owe.
4. Paying Your Contractors
Unless you are the Property Brothers, it is likely that you have a number of contractors with whom you work to get all the renovation done. In that vein, another common misconception with our house-flipping clients is that there are no tax implications with regard to hiring contractors for your homes. Don’t fall into that misconception.
If you pay a contractor, then in virtually all cases the tax law requires your business to file a Form 1099-MISC with the IRS. Specifically, the only times that you do not need to provide a 1099-MISC for a contractor is:
- If the contractor is incorporated and/or;
- If you paid the contractor less than $600.
So, don’t be surprised if a contractor with whom you worked asks you for 1099 at the end of the year. As a pro tip, a great way to get all the information to make the 1099 process easy is to have a contractor fill out a W-9 Form at the start of the job. You normally do not need to send the W-9 to the IRS, but it will have all the information necessary for you to complete 1099 when tax time rolls around.
Get a Tax Attorney in West Palm Beach to Help Guide You with Tax Questions
At Doane & Doane, we have the resources and experience with all of the above tax planning strategies to help you and your house-flipping business. Having handled many, many tax matters in the past, we are able to keep you away from missing tax requirements. Let us help you keep all your tax issues in order as your tax attorney in West Palm Beach.
So, if you would like a tax consultation, give us a call. Our advanced tax attorneys in West Palm Beach are ready to assist you and get you the peace of mind you need. Call Doane & Doane today for more information at 561-656-0200.