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 you may have to pay 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.
Flipping as an Investment
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 least a year and a day – the capital gains tax is between 0 and 20 percent, depending on your income.
Flipping as Income
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.
Understanding 1031 Exchanges
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.
Treating Your Flipping Expenses
You treat your expenses differently depending on 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.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.