The Beginner’s Guide to House Flipping and Taxes:
You spent weeks, months, or possibly more than a year flipping your first property. You carefully completed the renovations, finally completing your first flip and making a profit! Now you’re left with one question – how much will you have to pay in taxes for flipping the house?
Based on a variety of house flipping tax rules, your taxable amount owed for the house you flipped can change greatly based on several factors such as investor’s income and property type. It’s important to keep an eye on these factors, because the taxes associated with fix and flips can become very high if you aren’t careful.
In this article, we’ll explain how taxes work for flipping houses, such as how much you will have to pay and techniques for saving money on taxes.
You will learn about:
- Flipping Houses Tax Basics
- How much will I pay in taxes on my fix and flips?
- How can I calculate my house fix and flip taxes?
- When do I need to pay house flipping taxes?
- How to Save on House Flipping Taxes and Capital Gains Tax
Flipping Houses Tax Basics
If you want to figure out how much you will have to pay in taxes, you first need to understand the basics of how house flipping taxes work. Although there are occasional exceptions, house flipping is generally considered to be active income, rather than passive investing. Therefore, within the financial year the investor has to pay typical income taxes on their net profits, including self-employment taxes as well as federal and state income taxes.
If the majority of your income results from fixing and flipping properties, the IRS will usually classify you as a dealer. A dealer is considered to be someone who buys real estate for a short amount of time and then sells it to others. Even investors that only rarely fix and flip houses are still often classified this way. Real estate dealers pay business taxes rather than personal taxes, so your profits are taxed as income regardless of how long you hold the property. There are a few more discrepancies that can classify someone as a dealer versus a regular investor, and if you’d like to learn more you can explore this article here.
However, you should be careful with properties held long-term because if you hold a property for over a year, there’s a possibility of it being subject to the capital gains tax, which can go as high as 20%. These taxes are meant to apply mainly to long-term rentals or primary occupation situations, but sometimes do apply to flipping houses and capital gains. On the bright side, nonetheless, if you are paying capital gains taxes, the self-employment tax doesn’t apply anymore. There are also different kinds of capital gains taxes based on how long it takes you to sell the property when flipping houses, which are short-term capital gains taxes and long-term capital gains taxes.
Even if you only fix and flip houses on the side and don’t consider it to be a full-time business, the IRS says that any form of investment in real estate can be classified as a business, regardless of whether you do it under your name or as part of a different agreement.
How much will I pay in taxes on my fix and flips?
There are several factors that can affect how much you will pay in taxes total, such as your federal tax bracket and your income tax rate. In 2021, your self-employment taxes will come in at 15.3% up to $142,800.
Below are the updated single tax brackets for 2021. The filing deadline will be April 15th, 2022.
- Up to $9,950 will be taxed at 10% under normal rates, with no long-term capital gains tax
- Amounts between $9,950 and $40,525 will be taxed at 12%, with no long-term capital gains tax
- $40,525 to $86,375 will be taxed at 22% and long-term capital gains of 15% apply
- $86,375 to $164,925 will be taxed at 24% with long-term capital gains tax of 15%
- $164,925 to $209,425 will be taxed at 32% with 15% long-term capital gains tax
- $209,425 to $523,600 will be taxed at 35% with long-term capital gains tax of 15%
- Over $523,600 will be taxed at 37% with long-term capital gains tax of 20%
If you are married, these brackets will change slightly depending on whether you are filing jointly or filing separately with your spouse.
You will also have to pay state income taxes depending on your state’s tax brackets. This is where long-term and short-term capital gains come into play, as selling a property in under 12 months counts as a short-term capital gain, whereas over 12 months works as a long-term capital gain. Short-term capital gains will be taxed at your usual income tax rate, whereas long-term capital gain tax rates can be anywhere from 0% and 20%.
If you’re concerned that your real estate investment may no longer be worthwhile after taxes are taken out, you can prepare a mock-up of your investment and potential payouts using our hard money loan calculator.
How can I calculate my fix and flip taxes?
One rough method for calculating your flipping houses taxes is to multiply your normal income tax rate by the taxable profit you’ve made. While this may not be completely accurate, it will give you an estimate as to how much you’ll have to pay in taxes. Another option is to subtract your tax deductions from the final sales price of your fix and flip property, as well as subtracting your total expenses from the flip. This will show you your final profit after taxes have been accounted for.
When do I need to pay house flipping taxes?
According to the IRS, real estate property sales count as inventory, and so you don’t need to pay taxes until after that inventory has been completely sold. Therefore, you only need to pay taxes on your properties for the year in which you sell them. However, because real estate investors technically count as a business, if you make more than $1,000 in a year, you’ll need to prepay your taxes quarterly. File a 1040 Profit & Loss Form, also known as a Schedule C form, by the 15th of January, April, June, and September. If you haven’t successfully flipped any houses yet and haven’t made any income, you’ll need to file taxes at the end of the year.
How to Save on House Flipping Taxes and Capital Gains Tax
With a few entirely legal tips and tricks, you can cut back on some of the taxes that usually come with flipping a house.
One strategy to reduce your self-employment tax is to register an S-corp. If you then pay yourself what is considered a “reasonable salary”, you’ll only have to pay taxes on a percentage of that salary. Through owning your own S-Corp, you can also opt to receive dividends instead of a salary, which will be taxed less than your self-employment income. Finally, S-Corps even offer a 20% deduction for flow-through entities.
Another option is to file a 1031 Exchange form, which lets you avoid paying capital gains tax on a flipped house that’s been sold as long as you use the profits from that fix and flip to purchase another similar property. This can be a great option if you flip houses regularly. Some investors have been using 1031 exchanges for years without ever paying taxes on their fix and flips. More information on this strategy can be found here.
If you are only flipping one property at a time, and will possess said property for over a year, think about making that property your primary residence. While this isn’t an option for every investor, considering the timeline involved, doing so allows you pay less tax on your profits. The final sale will be classified as capital gains, rather than active income, and thus will be taxed at a lower rate.
Finally, make sure to save on taxes through writing off as many expenses as the IRS will permit. You should be able to deduct expenses such as office and vehicle expenses, building permits, and other related expenses. Some of these expenses can be deducted even before renovation begins, though others must wait until after you have successfully sold your fix and flip.
With tax brackets and IRS requirements changing frequently, it can be hard to stay on top of all the possible tax deductions. Keep in mind that you should always be tracking your expenses and numbers to find places to save. Understanding how house flipping tax rules and capital gains work is the first step to making filing taxes less intimidating. With the use of our convenient legal strategies to reduce how much you’re paying, you won’t need to worry about tax season anymore.
Adam Smith has spent the last 5 years in the Private Money Lending world helping real estate investors secure financing for their non-owner occupied real estate investments. When he’s not thinking about real estate, Adam is an avid Jazz music fan and fisherman.