Flipping Houses & Taxes
Flipping real estate can be a lucrative investment, as you can buy a house for a low price and then turn around and sell it for a profit. While this type of project has become a favorite of real estate investors, it comes with some tax consequences that must be considered.
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What Is Real Estate Flipping?
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The basic idea behind real estate is that you take a short-term approach to investing in real estate. You buy a house that needs some work and then fix it up. After performing renovations and repairs, you turn around and sell the house to someone else for more than you paid originally. Many investors who get involved with this type of project borrow part of the money they need from a lender and then pay off the loan when they sell the property.
Capital Gains Exclusion
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Many inexperienced investors who get into this market have the impression that you can sell real estate for a profit without having to pay capital gains taxes. Unfortunately, this exclusion is only for property that you use as your primary residence: If you sell your primary residence after living in it for two years, you can get out of paying capital gains taxes on the sale. With investment property, you get no such exclusion and you have to pay taxes on the entire amount of capital gains.
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Investing Vs. Business
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When you have a full-time job and you flip property as a side project, this is not considered a business, but an investment. When you buy and sell property for a living without any other type of income, then it can be considered a business by the IRS. When your profit comes from investing, you have to pay capital gains taxes on a money. If you hold the property for less than a year, it is taxed at the short-term capital gains tax rate, which is equal to your marginal tax rate. If you hold it for longer than a year, you can pay the long-term capital gains tax rate, which is generally a little lower than your marginal rate. If you do this as a business, the profits are always taxed at your marginal tax rate.
1031 Exchange
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When you invest in real estate on a part-time basis, you can sometimes take part in a 1031 exchange. With a 1031 exchange, you can use the money that you generate from the sale of a property to buy another investment property. When you do this, you do not have to pay capital gains taxes on the money you earned from the original sale. If you flip properties for a living, you cannot take advantage of this process.
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