Tax Reporting for Flipping Houses
Investor vs. Dealer
- It is important to determine how the Internal Revenue Service views the real estate activities of the person flipping the house. The IRS states that a person is considered a real estate investor when the property purchased is held for long-term value appreciation and if the real estate is not the investor's primary occupation. Dealers, the legal name for a flipper, are typically interested in holding properties only for a short time. Real estate flipping is often the primary occupation of a dealer; however, this is not always the case. Investors are taxed on their gains at 15 percent and are not liable to pay self-employment tax of 15.3 percent. A disadvantage of being classified as an investor is that investment losses for tax purposes are capped at $3,000. Dealers are assessed short-term capital gains tax at the individual income tax rates and may also be liable for the 15.3 percent self-employment tax.
- Dealers are required to pay the 15.3 percent self-employment tax. The self-employment tax is comprised of two parts: Social Security tax (12.4 percent) and Medicare tax (2.9 percent). Self-employment tax is levied at 15.3 percent on the first $106,800 of income; however, any income over $106,800 is taxed at a discounted rate of only 2.9 percent. IRS rules permits the taxpayer to deduct one-half of his self-employment taxes from gross income on the federal income tax return.
Short-Term Capital Gains Tax
- Dealers are required to pay short-term capital gains tax on the profits of their house flips. This tax is based upon the individual income tax rates of the house flipper. These tax rates, as of 2011, may vary from 15 percent to as high as 39.6 percent. Real estate dealers are permitted by the IRS to deduct the entire amount of a loss on a house flip, a distinct advantage that dealers have over investors.
- Real estate dealers can defer the taxes from a previous house flip by using the gains earned to invest in a different property. This is possible by utilizing a tax concept known as 1031 exchange, also known as a like-kind exchange. The taxes owed on the previous flip are deferred, but are still owed at a later date. Properties involved in a 1031 exchange must be income-producing properties; properties that are personal assets are not permitted in a 1031 exchange.