One key component of maximizing your profits as a fix-and-flip investor is understanding the tax implications.
A thorough grasp of the tax considerations will lead to successful flipping projects that more closely align with your investment goals.
Whether you’re new to fix-and-flip projects or want to refine your approach and enhance your bottom line, read on for five strategies to maximize your tax benefits.
Get Started with Park Place Finance1. Know your tax status
The tax implications for a fix-and-flip property hinge on two main concepts: the duration of your property holdings and your classification under tax law.
Short-term vs. long-term capital gains
The profits you make from your real estate investments are subject to capital gains tax.
Your tax rate depends on how long you hold the property before selling it.
Short-term capital gains
Fix-and-flip profits are considered short-term capital gains if the property is bought and sold within 12 months.
Short-term capital gains are taxed at the regular income tax rate, which can range from 10% to 37% (as of the latest tax brackets) depending on your taxable income for the year.
The higher rates are because the IRS views short-term gains as ordinary income.
Long-term capital gains
If you hold the property for more than a year before selling, your profits are considered long-term capital gains.
Long-term gains have reduced tax rates of either 0%, 15%, or 20% depending on your overall income level.
Due to the tax benefits of long-term gains, it may sometimes make financial sense to extend the holding period beyond one year to benefit from lower tax rates.
Dealer status
The other important aspect of your tax considerations as a house flipper is whether the IRS classifies you as a real estate investor or dealer.
- Real estate investor: Purchases real estate to hold properties long-term to generate rental income or to sell the property for a profit in the future
- Real estate dealer: Frequently buys and sells real estate with the intent to make a profit
The key distinction between an investor vs. dealer lies in the intention for the properties and the transaction frequency.
Dealer profits are considered ordinary business income, which is subject to both income tax at your normal rate and self-employment taxes.
Dealers cannot benefit from long-term capital gains tax rates, even if they hold a property for longer than a year before selling it.
They also cannot qualify for the 1031 exchange, which excludes properties bought for resale.
2. Keep accurate records of expenses
House flipping requires meticulous record-keeping and an understanding of how the IRS categorizes different expenses.
These records will help you identify expenses you can deduct to reduce your taxable income, including:
- Closing costs
- Renovation expenses
- Marketing costs
- Loan interest
- Operating expenses
Capital improvements vs. repairs
- Capital improvements are expenses that are not immediately fully deductible but are capitalized and depreciated over some time. These expenses include kitchen upgrades or new HVAC systems.
- Repairs, on the other hand, are fully deductible in the year they are made. Examples of repairs include painting or replacing broken windows.
3. Flip your primary residence
If you’re new to the world of fix-and-flip investments, consider flipping your own property to take advantage of the Section 121 exclusion.
If you lived in the property for at least two of the five years before selling, you can exclude up to $250,000 of profit if filing as single, or up to $500,000 if filing jointly.
You also will be able to deduct mortgage interest and property taxes, as with any primary residence.
This strategy requires careful planning to ensure you meet the residency requirements without delaying your flipping operations.
4. Operate as an LLC or S Corporation
Choosing the right entity structure for your house flipping business can significantly impact your taxes and personal liability exposure.
Entity structures include:
- Limited liability company (LLC): Provides liability protection by separating personal assets from business debts and liabilities
- S Corporation: Profit distributions above the investor’s salary are not subject to Social Security or Medicare taxes
Consult with a tax and legal professional to ensure you’re making the right moves for your fix-and-flip business.
These professionals can provide guidance tailored to your specific situation to help you maximize your tax benefits.
5. Hold the property for longer than a year
Sometimes it may be more helpful to hold onto your properties for longer than a year to avoid being categorized as a dealer.
Longer holding periods give real estate investors access to lower capital gains tax rates, and they qualify for the 1031 exchange.
The 1031 exchange allows investors to defer capital gains taxes by reinvesting the proceeds from one sale into another “like-kind” investment property.
This approach requires a clear demonstration of intent to hold the property for investment purposes.
Bonus tip: Diversify your investment portfolio
Diversifying your investment portfolio isn’t just a risk management strategy— it can offer significant tax benefits.
A mix of fix-and-flip and rental properties across various real estate markets unlocks access to the following tax advantages:
- Optimizes capital gains
- Maximizes deductions, including access to depreciation
- Smooths income fluctuations
Overall, diversification provides a stronger and more stable investment portfolio that can weather the storms of the real estate market.
Fund your next fix-and-flip with Park Place Finance
Your house flipping success relies on the right type of financing for your projects.
Park Place Finance is your trusted hard money lender, with over $1 billion in loans funded across 47 states.
Each of our borrowers has access to an account executive who will provide guidance and support throughout the loan process—and beyond.
We offer the following loan products:
Park Place Finance can close on fix-and-flip loans as fast as three to five business days, with competitive interest rates.
Start here for a quick rate quote, or call us at (866) 407-1599 to speak with an account executive now.
Whether you plan to fix and flip, fix and hold, or construct a property from the ground up, we have solutions for you.