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For Real Estate Flippers Tax Law Makes The Difference
Staff - Mortgage Lenders Plus.com
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While housing prices have cooled in many markets, there are still some hotspots. Real estate investors are Gypsies when it comes to turning a quick sale: they will go where the home appreciation rates are still hot. In recent months they have abandoned Sacramento for parts of Arizona and New Mexico; as a result the sales rates in Sacramento have dropped considerably, along with the appreciation rate. What has not changed in any of the markets is the application of capital gains tax law.
Buying a house and then selling it after a short period may turn a profit for you, but how much of a profit depends on how the IRS views the transaction. Current law still applies a form of capital gains tax law to most home sales, with the rate depending on a couple of factors. If you owned it for less than a year, the profit will be taxed at your income tax level; for many of us that’s about 35%. If you hold on to it for a year or more, the tax rate on sales profit will be at a lower capital gains rate, usually about 15%.
If and only if the home is regarded as your principal place of residence, up to $250,000 in profit - or $500,000 if you are married and filing jointly - will be exempt from the capital gains tax on home sale. In order for a home to qualify as a principal residence, you must have lived in it at least two years out of the last five.
Capital gains tax law also provides that you can defer taxes by exchanging the house you’re flipping for another piece of real estate; known as a like-kind or Section 1031 exchange. The only restriction is that the property you are trading is an income producing asset and not personal property. Otherwise, you can trade a residence for a commercial property or a structure for a piece of land. The parameters are fairly broad as long as the house has been a business asset; thus the capital gains tax on home sales do not apply.
There is also a rule of moderation in this practice. If you engage in a lot of real estate acquisition and resale over a relatively short period, the IRS may look upon the sum of all that activity as a business, rather than an investment strategy. If they chose to do so, the capital gains tax law will not apply and the tax rate on your transactions will be based on the income tax index.
The leveling off in the housing market is going to take a lot of dabblers out of this business. Nevertheless, if you see continued opportunity in real estate trading it would be wise to consult your tax accountant as to the allowable level of activity and to ascertain the details for each of the rules that define this activity in capital gains tax law.
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