Real estate can be a tempting alternative when the stock market is volatile, especially if you've found a property that seems to be available for a below-market price. But this kind of investment can involve navigating some tricky waters, so make sure you understand the consequences and the laws in your state before taking that dive.
A house is "flipped" when it's purchased by an investor, who makes repairs and possibly renovations and then sells it quickly in the hope of turning a large profit. The process was so popular during the housing boom of the 2000s that it inspired several TV shows, such as A&E's "Flip This House."
However, the bursting of the housing bubble took its toll on investors, as evidenced by this description on AETV.com: "...with the current slump in the housing market, the casts of A&E Network's series 'Flip This House' are facing hard truths and real panic as they return for a 4th Season." (See References 2)
Most investors stay on the right side of the law and legitimately purchase properties at a discount, fix them up, and sell them for a profit, but others are not as scrupulous. The process can encourage mortgage fraud, in which an investor buys a property, an associate gets a mortgage based on an artificially inflated price, and then the two split the amount that's above what the investor paid for it. An investigation by the Sarasota Herald-Tribune in 2009 determined that $10 billion in suspicious deals took place in Florida alone during the housing boom. (See References 1)
There are no federal laws that specifically address flipping a house, but in 2003, the U.S. Department of Housing and Urban Development (HUD) instituted a few new rules regarding mortgages issued by the Federal Housing Administration (FHA) in an effort to prohibit predatory lending and flipping. These included a provision that the property being purchased must have been owned by the seller for at least 90 days before the sale. If the property was owned for more than 90 days but fewer than 180, the lender must get an additional appraisal from an independent appraiser that confirms the value of the property.
If the property was owned for more than 90 days but less than a year and is in an area where flipping has been a known problem, the lender might be required to supply additional documentation, such as proof of renovations or improvements, to substantiate the value.
Some states are beginning to take action to curtail flipping. Washington instituted a law in 2008 that requires investors who plan to make more than $500 in improvements to a property to be a registered contractor or to own the property more than a year before selling it. People who build houses on spec, or without a particular buyer in mind, are also subject to the law.
The U.S. Internal Revenue Service (IRS) requires investors who purchase a house and sell it without living in it to pay higher taxes on any profit than a homeowner would. Since 1997, the IRS has taxed the profit from the sale of a home only if you didn't use it as your principal residence for at least two years in the five years before the sale or if you made more than $250,000 ($500,000 for some joint returns) on the sale.