taxes

Tax consequences of flipping real estate

During the heyday of continually rising real estate values, "flipping" -- buying a property and then reselling it at a higher price -- was all the rage.

In regions where property prices have fallen, flipping has flopped. But it still can be a worthwhile investment option as long as you also are aware of its potential pitfalls. Or, as accountant Bill Rucci warns, "It may not be as lucrative as you first thought."

Many people view real estate investing as more lucrative than the stock market. Plus, flippers enjoy the tangible aspect of the deal. Because property is "real," you can look at a house and neighborhood and get a personal take on whether it's a good investment.

If you're not careful with your real estate flips, though, your investment strategy could produce a sizable payoff for an unintended partner: the Internal Revenue Service.

Real estate tax confusion
Rucci, a CPA and partner in the Boston-based accounting firm Rucci, Bardaro and Barrett, says that many of today's real estate investors go into the transactions completely uninformed.

"There is a huge misconception on the part of some people who think they can buy a residential home, not necessarily their personal residence, fix it up and then sell it; and then get what we used to call 'the old rollover provisions,' where you used the money you made to buy another piece of property for more than what you sold," says Rucci.

But, says Rucci, there are two problems with that approach. "One, that rule existed for personal residences only; and two, it doesn't exist anymore."

The rollover rule was replaced in 1997 by the current law that allows, in many cases, for the tax-free sale of a personal property. This is a great tax break if you're selling your primary residence after having lived in it for several years, but it does nothing for you, taxwise, if you're selling a house in which you have never lived. In this case, the residence is an investment property, and the tax considerations are completely different and definitely more costly.

High expectations, higher taxes
Just as costly is the mind-set of many real-estate speculators.

"We had tens of thousands of people getting into real estate. There was a gold-rush mentality that, 'If I invest in condos, I'll make money,'" says Mark Zilbert, a Realtor and real estate broker whose Zilbert Realty Group created an offshoot in 2005, CondoFlip, to tap the then-hot Miami marketplace where his company is based.

"The majority of buyers understand that they can flip for a profit, understand what it means dollarwise, but they don't understand that taxes could reduce just how much of a profit they make," says Zilbert.

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Lonnie Davis, a CPA with the Philadelphia office of CBIZ Accounting, Tax and Advisory Services, agrees.

"The biggest issue during the real estate boom with prices rising very quickly, was that people wanted to capitalize on their gains, to take the money and run, so to speak," says Davis.

Invest in patience as well as properties
Instead of running, a tax-smart flipper could benefit from a slightly slower investment pace.

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