House flipping—the process of buying a property, renovating it, and then selling it for a profit—is a great way to earn some extra money. However, if you're not careful, you could end up owing quite a bit in taxes. Here are a few tips to help you minimize your tax liability as a house flipper.
Don't Overlook the Capital Gains Tax
If you sell your flipped property for a profit, you'll owe capital gains tax on that profit. The capital gains tax rate can be as high as 20%, so if you make $50,000 on a flip, you could owe Uncle Sam $10,000. Ouch!
There are a few ways to minimize or even avoid capital gains tax on your flips. One is to take advantage of the step-up in basis rule. This rule allows you to increase the cost basis of inherited assets to their fair market value at the time of inheritance. So, if you inherit a property from a family member and then flip it, you may be able to avoid paying any capital gains tax at all.
Another way to reduce your capital gains tax liability is to utilize a 1031 Exchange. A 1031 exchange allows investors to defer paying capital gains tax on the sale of an investment property by reinvesting the proceeds from that sale into another qualified investment property. However, there are some strict rules that must be followed in order to do a 1031 exchange, so please contact us if you'd like to learn more about the process.
Keep Good Records
The IRS allows house flippers to deduct many of the costs associated with flipping a house, but you'll need good records to take advantage of these deductions. Make sure to keep receipts for all materials, labor, and professional services related to your flip. If you hire contractors, be sure to get 1099 forms from them so that you can deduct those expenses come tax time. And if you take out any loans to finance your flip, keep records of the interest paid on those loans—you'll be able to deduct that as well.
Be Careful with Home Offices
If you use part of your home as an office for your house-flipping business, you may be able to deduct some of the related expenses come tax time. However, there are very specific rules about what qualifies as a home office, so be sure to speak with your accountant before taking this deduction. Otherwise, you could end up getting audited by the IRS. Trust us—you don't want that!
Maximize Your Deductions
There are many potential deductions available to house flippers, but not all of them will apply in every situation. Some common deductions include the cost of renovations, the interest on your loans, and any real estate taxes paid during the course of the Flip.
When In Doubt, Talk to a Pro
House flipping can be a great way to make some extra money—but it also comes with its own set of taxes and responsibilities. When in doubt about any of the rules, speak to a qualified tax professional. If you have questions specific to the 1031 Exchange process, our Qualified Intermediaries are here to offer guidance and assistance. Please contact us at (888) 508-1901 to schedule a consultation.