Flipping Houses and Taxes: What You Need to Know

Important Note: This article is for informational purposes only. Before filing your taxes, we recommend consulting with an accounting professional.

With home prices still rising, now is a great time to buy a home, make a few strategic updates, and sell it for a nice profit. But how does flipping a house affect your taxes?

Thankfully, taxes on flipping houses aren’t as complicated as they may seem—and they shouldn’t stop you from pursuing great deals! In this article, we’ll look at what you should know about flipping houses and taxes before you buy your first fixer-upper.

House-Flipping Taxes: The Basics

How much you pay in taxes when flipping houses depends entirely on whether the IRS views you as a real estate investor or a real estate dealer. It also depends on your overall income in the year you sell the house, how you’re filing your taxes, and where you live.

Important Note: As part of your research you may have seen that there have been court cases over these taxes because the laws surrounding house-flipper taxes aren’t clear-cut. We recommend consulting with an attorney and accountant before buying a home to flip or filing your taxes in your state.

Real Estate Investor vs. Real Estate Dealer

In general, a real estate investor is someone who owns and holds properties long-term. A real estate dealer, on the other hand, purchases and sells properties quickly and repeatedly. That’s why the IRS ends up categorizing many wholesalers and house flippers as real estate dealers instead of investors.

If the government classifies your house flips as dealer activities, it can increase how much you pay in taxes. But the good news is that there are still several things you can do to ease that tax burden as a dealer.

Taxes for Real Estate Investors

Investors tend to pay less in taxes on their real estate income than dealers do. This is because their homes count as capital assets in the eyes of the IRS. When an investor sells a house, they pay either short-term or long-term capital gains tax, depending on how long they owned the property.

Short-Term vs. Long-Term Capital Gains

Investors who hold properties for under a year before selling have to pay short-term capital gains tax. Short-term capital gains are taxed as regular income, so the exact rate can range from 10% to as high as 37% depending on the investor’s overall income that year.

Here’s how the various rates will break down for the 2022 tax year:

If you own the property for over a year before selling, you’ll pay long-term capital gains. These rates range from 0% to 20% and, once again, depend on your overall income in the year you sell.

Here’s the rate you can expect to pay based on your taxable income and filing status:

Depending on where you live, you may also have to pay state capital gains tax. And if your income exceeds $200,000 (or $250,000 if married and filing jointly), then you’ll also need to pay the Net Investment Income Tax (NIIT).

Taxes for Real Estate Dealers

Most serious house flippers don’t qualify for lower long-term capital gains tax rates because they aren’t classified as investors. Why? Because in order to make a livable income flipping homes, you’d have to sell multiple homes per year. In most cases, that would cause the IRS to classify you as a dealer.

As a dealer, you have to pay regular income tax on the profit you make from flipping houses. You also pay a self-employment tax of 15.3%. (These are the same as FICA taxes, which go toward Medicare and Social Security.)

Another thing to keep in mind is that dealers can’t take advantage of certain real estate tax benefits. For example, dealers aren’t allowed to do 1031 exchanges (pronounced “ten-thirty-one”), which would allow you to put off paying taxes on a home sale by using the profit to pay for another property of equal or greater value.

Tip: As a wholesaler, it's important to be aware of tax implications. The income you make from a wholesaling deal is typically subject to regular income tax as most wholesalers collect an assignment fee and don't sell the property themselves. To avoid losing a larger chunk of your wholesale commission than necessary or getting into trouble with the IRS, you may want to consult a tax professional.

How to Reduce Your Tax Burden as a House Flipper

Even though most house flippers don’t get the same tax benefits as long-term investors, there are still several things you can do to reduce your overall tax burden.

Tip: Remember, this article isn’t meant to be taken as personal legal or tax advice. Make sure you speak with your professional tax advisor and attorney before buying a house you want to flip.

Operate Under a Separate Business

Putting your house-flipping activities in a separate LLC can help offset certain taxes. If you elect S Corporation status, you can reduce the amount you pay in self-employment tax by taking part of the profit as a salary and the rest as a distribution. (Ask your CPA about the best way to do this.)

Separating your active real estate dealings from your passive investments can also help protect you from paying a higher tax rate on all your real estate income.

Flip Your Own Home

If flipping houses isn’t your main source of income, you can reduce taxes on a sale by using the Section 121 exclusion. This allows you to exclude up to $250,000 of the gain on your taxes (or up to $500,000 if you’re married and filing jointly).

To qualify for this exclusion, the house you’re flipping has to have been your primary residence for at least two of the five years leading up to the sale. Keep in mind that you can’t use the Section 121 exclusion if you already used it in the last two years on another home.

If you’re just starting out, this is a great strategy for getting your feet wet with house flipping.

Track Your House-Flipping Tax Deductions

Another way to lessen your house-flipping taxes is to keep careful track of all your related business costs.

You may be able to deduct some of your expenses immediately from your taxable income. This may include costs like office rent and utilities, loan interest, legal and accounting fees, and travel expenses.

Others, known as “capitalized expenditures” or “capitalized costs,” can’t be deducted until you officially sell the house. Some common capitalized costs for a house flip include:

• The cost of buying the home
• Renovation labor costs
• Materials for renovating
• Utilities for the home
• Insurance

Be sure to talk to your accountant about which of your expenses can be deducted immediately and which count as capitalized costs.

How to Find Your Next House to Flip

Once you understand how flipping houses and taxes work together, you’re one step closer to getting started! Now it’s time to research where you want to buy, who your target market is, and how much you can realistically invest in a renovation.

Next, you need to start analyzing specific properties. There are plenty of homes that would yield an excellent profit, but remember, not all houses make good flips. Avoid properties that would cost more to fix up than you could earn back when selling. You can do this by assessing the condition of the property, how much it would cost to fix it up, and how much it could sell for in that market.

Tip: Use Our Rehab Calculator to plan out renovation costs!

Learn the exact steps to successfully flip homes in PropStream’s in-depth course Fix and Flip Like a Pro: Find Properties & Maximize ROI. You’ll learn all about how to find properties, effectively market your house-flipping business, analyze specific deals, finance your flips, and sell your houses at top dollar.

Enroll for free today!