| Tax
consequences of flipping real estate | | |
| Investment profit, regardless
of whether it comes from sale of stocks or real estate, is considered capital
gain and is taxed at two levels. The tax rates depend on how long you own
the property.
Hold an asset for a year or less and you'll face
short-term gains that are taxed at ordinary income-tax rates. This could be as
high as 35 percent. If your investment timetable is lengthier, federal tax laws
reward you. By holding an asset for more than a year, you'll face the long-term
capital gains rate that maxes out, in most instances, at 15 percent. Not
all flippers, however, are able to wait on their profit, even when facing the
threat of higher taxes. "They have this brilliant idea
to buy a house, buy a residential piece of property, fix it up and sell it; and
then they want to do it for a new piece of property," says Rucci. When flippers
find out they don't get the residential replacement rollover, they say "'OK,
I made money. I'll pay the tax and buy another house.'" Such
an approach could indeed net more cash. But continual property flipping also could
create additional tax problems. IRS eyes
flippers
When you complete several real estate transactions in a short
time, don't be surprised to learn that the IRS might consider your property transactions
as a business or trade rather than as an investment strategy, says Davis. In that
case, there's no way to get out of paying the higher ordinary income tax rates.
So what's the business-versus-investment
determining factor when it comes to property flipping? As with many tax issues,
it depends. "It's a facts-and-circumstances test,"
says Davis. "There's no rule of thumb that says: Buy three houses, you'll
get capital gains; buy five and you're a dealer-trader. The IRS looks at whether
the activity is really a business. "Are
you buying, renovating and holding multiple properties? What's the frequency of
the buying and selling? If you're acquiring 15 properties in a year and that's
pretty much what you do, then the IRS will likely determine that you're a dealer."
And make no mistake about it, the IRS is looking closely at these
transactions. Much attention has been given recently to the tax gap: The amount
of money the IRS believes it is owed but hasn't been able to collect. Collecting
taxes on real-estate-flip profit is one way to close that gap. "The
IRS is out looking for these transactions," says Rucci. "If the IRS
decides your investment is a business; that what you're doing is to earn a living,
the property changes from a capital asset to a means of producing income that's
subject to ordinary tax rates, plus the additional burden of another 15.3 percent
in self-employment taxes. And that's what the government is pushing for." "There's
going to be a wake-up call for tens of thousands of people," says Zilbert.
"They made good money. Still they'll see a dramatic reduction from what they
thought they would make." Flipping
the tax tables
Tax costs, though, aren't going to deter some flippers,
says Zilbert, especially those who've purchased in areas where property appreciation
has been so great. | 
