How To Pay Less in Taxes When Flipping A House

Those popular fix-and-flip TV programs? They never show the successful house flippers stooped over their coffee tables, pulling out their hair, trying to figure out how much of their profit to pay in taxes.

In reality, taxes are a big part of the house flipping business. You could pay less in fix-and-flip taxes by planning your flip with taxation in mind.

Fix and flip taxes: how they work

By definition, most house flippers are short-term real estate dealers. When you buy a home and fix it up, the home becomes part of your inventory. When you sell the home, you’re taxed on the sale.

Plus, you pay self-employment taxes on the personal income you earned from completing the deal.

But you can lower your fix-and-flip taxes by understanding more about how these taxes work. Your tax burden will depend in part on your:

• Ownership time: Will you resell the home within a year? If so, you’ve earned short-term capital gains. Short-term capital gains are taxed like your other income. In contrast, profit on a home you owned longer than a year should be taxed at a lower long-term capital gains rate
• Business structure: Flipping homes as a Limited Liability Company (LLC) or an S-Corporation, instead of doing business as an individual sole proprietor, could allow less fix-and-flip taxes
• Deductions: Rather than deducting expenses from your taxable income, most house-flipping expenses will be capitalized — meaning they’ll be added to the value of the home, lowering the tax burden when you resell the home

There’s no one-size-fits-all formula for paying less in fix-and-flip taxes, but when you adjust these variables to match your unique situation, you can save money at tax time.

Ways to lower fix-and-flip taxes

Here’s the best piece of advice for new house flippers who want to control their tax liability: Call a certified public accountant (CPA) or professional tax preparer in your area. Better yet: Find a CPA or tax pro who knows the real estate industry.

These experts know so much more about tax law than you can learn in an overview like this one. They’ll know how to match your tax strategy to your business plan.

In the meantime, you can get started limiting your fix-and-flip taxes by:

Keeping track of all your costs

Experienced house flippers keep immaculate records. They keep track of every dollar they spend on every project. Expenses can include:

• The home’s purchase price
• Labor and materials
• Professional services
• Utilities
• Mortgage interest paid to the lender
• Property taxes and homeowners insurance

Not sure whether to record an expense? Record it anyway. Better to have more receipts than you can use than to scramble for receipts months after you’ve spent the money.

Keeping the home at least a year

Can you find a way to keep the home on your books for longer than a year? Doing so will flag your profits as long-term capital gains. Long-term gains tend to be taxed at a lower rate than short-term gains.

That said, if it’s advantageous for you to count your profits as regular income, you can do this by owning the home for less than a year. Taxes in the U.S. are super complicated, so this is a question for a tax pro.

Living in the home at least two years

Home sellers get a big tax break on capital gains from homes they’ve lived in as their primary residence. (See 121 Exclusion.) But you’d need to live in the home at least two years to qualify for this break.

Some flippers do this: They live in a home while fixing it up. Then, after two years, when the home’s in great shape, they sell and move into a new fixer-upper, starting the process over again.

Combining fixing-and-flipping with landlording

Securities investors like to limit their taxes by building diverse portfolios. For example, they might pair a tax-heavy investment with a tax-preferred investment. That way, the tax costs and tax benefits balance each other out.

Residential real estate developers can do this, too, by mixing fix-and-flip projects with long-term rental properties. The depreciation write-off, and other losses on long-term rentals, can offset the capital gains from home flips.

DSCR loans are a great way to start building a portfolio of long-term rentals.

Creating a new company and paying yourself a salary

If you’re fixing and flipping one house, and you don’t plan to turn this hobby into your full-time gig, you may be OK paying individual taxes on your earnings.

But if you want to make fixing and flipping a way of life, you should consider creating a corporation. Opening an S-Corporation or a Limited Liability Company (LLC), for example, is a simple job for a CPA or an attorney.

This strategy keeps your personal finances separate from your business finances. You’d pay yourself a reasonable salary for running the business. Then you’d be taxed on that income like any other salary owner.

Meanwhile, your company could pay less fix-and-filp taxes than you would have paid on the same profit as an individual.

House flipping tax example

So just how much will you owe in taxes on a flip? The following example shows the full tax burden with no deductions on a short-term fix-and-flip — one you’d complete in less than a year.

First, about the project itself:

• Home purchase price: $150,000
• Renovation costs: $40,000
• Total amount spent: $190,000
• Resale price: $240,000
• Before-tax profit: $50,000

On that $50,000 in profit, you’d owe:

• *22% short-term capital gains (income) tax: $11,000
• 15.3% self-employment income tax: $7,650
• Total federal income tax: $18,650
• Your profits after taxes: $31,350

*This is just a simple example. Your short-term capital gains tax rate would depend on your income tax bracket. Highest earners could pay up to 37% on some earnings. The self-employment tax rate of 15.3% stays the same. (It covers Social Security and Medicare.) 

Whatever your income bracket, this example shows the importance of limiting fix-and-flip taxes. Most flippers who pay the full tax bill once start finding ways to lower their rates before starting a new project.

Start limiting fix-and-flip taxes before you flip

Paying the full fix-and-flip tax burden turns the IRS into a silent partner, a partner who demands a lot and won’t stay silent long if you’re slow paying its share.

Before you start shopping for homes to flip, start thinking about ways to limit your taxes. Find a CPA or tax preparer who can answer your questions about your unique plans.