"Flipping" is a term that originally referred to selling a house before you close on it by having someone essentially pay you to assign your purchase agreement to them. But most people use the term more generically to refer to buying and quickly reselling a house for a higher price. When it works, you can make some money, but flipping comes with a cost.
Risk of Losing Money
One of the biggest disadvantages to flipping houses is that it doesn't always work. If you can't resell your purchase agreement, you could end up losing your deposit when you back out, or get stuck buying a house that you weren't planning to. Flippers who buy, rehab and sell can lose money if rehabs cost more than anticipated, if the market shifts downward, or if buyers aren't interested in the house.
When you do a successful flip transaction, you probably got a good deal when you first placed the house under contract. When you flip it, you get your equity and profit back, but you then need to reinvest that money. Holding on to a property that you bought right as a rental can sometimes generate a healthy monthly cash flow. Flipping it means that you miss out on the opportunity to collect that ongoing income stream.
Ineligibility for 1031 Exchange
One of the most lucrative parts of real estate ownership is the ability to do a tax-deferred exchange when you sell. 1031 exchanges let you avoid paying capital gains tax or recapture tax as long as you sell and buy more property. However, you can file a 1031 only with investment property, and flipped transactions frequently don't qualify because they're typically speculative and short term.
Short-Term Capital Gains Tax
In addition to not being able to qualify for 1031 exchanges, if you flip a house after owning it for less than a year, it doesn't qualify for long-term capital gains treatment. The Internal Revenue Service uses a special low rate for long-term gains. Short-term gains, though, get taxed at your regular marginal income tax rate. So, you'll keep less of your profit if you flip the house than if you rent it out for a year or two and then sell it. Doing the latter could even make your investment eligible for a 1031 exchange.
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- The 1031 Exchange Experts: Why 'Flipping' Won't Work in a 1031 Exchange
- IRS: Topic 409 - Capital Gains and Losses
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