When you buy and resell a house without ever living in it you've flipped the property. If the home's price rises, flipping is a profitable investment strategy, though a risky one if housing prices drop: You may wind up selling at a loss, or paying the mortgage long after you thought you'd be done with it. Your tax rate depends in part on how the IRS classifies your flipping.
If flipping homes is a sideline to your main source of income, the IRS regards it as an investment subject to capital gains tax rather than income tax. If you flip a house in a year or less, you pay short-term capital gains tax, which is the same as your regular tax rate. If you hold the property long term -- at leas a year and a day -- the capital gains tax is only 15 percent.
If flipping homes is your career -- you buy and sell multiple properties and rely on it for most of your income -- the IRS treats it as self-employment income. No matter how long you hold the property, you pay regular income taxes on your profits. You also have to pay self-employment tax, which runs 15.3 percent. There's no specific dividing line between investment and income flipping, so even if you have a day job, the IRS may treat your flipping as regular income if you do a lot of it.
A 1031 exchange is a way to postpone your taxes: If you swap the house you're flipping for another property, you don't pay taxes on the sale. You can swap the next house too, but when you finally sell a house for cash and take your money out, the tax bill comes due. While you can apply the 1031 rule to a variety of different properties, they have to be investments: You can't claim the tax break if you trade an investment house for your next personal home.
You treat your expenses differently depending whether flipping is investment or income. If the IRS classifies your home-selling as income, you claim your expenses -- real-estate taxes, property repairs, interest -- as deductions from your business income. With investments, they're adjustments to your capital gains: If you buy a home for $100,000 and sell it for $200,000, but you also put in $20,000 in repairs, your gain is $80,000 rather than $100,000.
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