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 time table 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 flippersWhen 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 tablesTax costs, though, aren't going to deter some flippers, says Zilbert, especially those who are able to purchase in areas where property is still appreciating, albeit at a slower pace, or who have held the property long enough to see substantial gains.