Bradley Ransome is a real estate investor who focuses on purchasing, renovating, and selling unpopular properties that may otherwise sit on the market untouched. In the following article, Brad Ransome explains that house flipping has been growing in popularity in recent years, but the related taxes can often cause confusion and cut into profits.
Real estate flipping is rapidly becoming an increasingly popular option for investors wanting a simple and reliable way to make an income in the market. However, it isn’t always quite as straightforward and simple as it seems. With a variety of real estate flipping shows on TV – many unknowing people may think flipping a property is something anyone can do. Right? Bradley Ransome explains that “easy” is not always the case, and investors looking to make the most of their new opportunities should always monitor closely the role between house flipping and taxation.
Real Estate Flipping
Brad Ransome explains that this concept refers to the process of buying a property at a low price, usually under market value due to the condition of the home. Homes selling for under market value in today’s landscape usually require thousands of dollars of work to get them back into “move-in-ready” shape. Once renovated, the property is resold for a (hopefully) substantial profit.
In some cases, this can happen when an investor finds a bargain property and resells it for a higher price. However, most flipped properties require an intermediary stage to make a profit. This usually involves renovating or extending the property’s square footage.
Real estate flipping isn’t a new trend. However, Bradley Ransome says that this form of real estate can offer numerous benefits for investors, both financially and from a practical perspective. Accordingly, it’s perhaps unsurprising that so many investors are jumping on the turnover bandwagon.
However, before an individual makes their first investment into such a project, considering the potential tax ramifications is crucial, and oftentimes, overlooked. Indeed, many new investors overlook how much tax they’ll end up liable for after flipping a property – which can be a massive mistake from a profit perspective.
How Much Tax is Paid When Flipping
Unfortunately, while it no doubt offers a lucrative earning opportunity, Brad Ransome explains that real estate flipping can come with pretty hefty tax bills. In part, this can be attributed to the high profit margins that are possible on these turnover properties.
However, it’s worth considering also that the IRS typically classifies house flippers as “dealers”. In such cases, on top of the regular tax, house flippers are also liable for self-employment tax.
In other words, Brad Ransome says that the profits made when flipping real estate are often charged twice. This isn’t great news for investors since it leaves them with much less take-home tax at the end of the day. As such, investors may want to consider flipping houses as a sole proprietor to keep the taxes down. However, this comes with other risks and drawbacks (e.g., unlimited liability).
Brad Ransome explains the following example for clarification – A property is purchased for $250,000, and $20,000 of renovations are completed. This takes the total cost to $270,000. The property is then sold for $297,000.
In theory, this is a solid 10% profit of $27,000. This ties in with the average return of $30,000. However, if this profit is taxed twice, it can easily drop by around 25% or more. Ouch!
And that’s assuming the individual only completes one property per year and has no other income. With higher profits or greater numbers of properties, the tax cut could be even higher!
Expenses That Can be Claimed
A real estate investor/flipper can claim several expenses as part of their work. Of course, the cost of purchasing the property can be claimed; however, this cannot be reclaimed until the property has been resold. Bradley Ransome explains that an unsold property cannot have its purchase price reclaimed. Of course, this can be a potential concern for many investors.
The problem becomes apparent here when looking at tax years. If an investor buys a property not long before the tax year ends, they won’t be able to reclaim this expense until the following tax year.
Therefore, investors should take care to ensure their bank balance is still able to afford taxes after purchasing a new project property. Failing this, it’s easy to end up unable to afford taxes.
Naturally, it’s also possible to reclaim the costs of expenses before paying taxes. For example, expenses incurred during the process may be claimable, depending on the nature of the costs. However, this sum is usually negligible versus buying the property initially according to Bradley Ransome.
Final Thoughts
For someone looking to try house flipping, be prepared to pay a lot of taxes. The tax rate on flipping depends on many different scenarios. However, it usually ranges between 10% and 37% in total. As such, investors must ensure they have effective solutions in place before getting started to minimize risk of getting stuck with a hefty tax bill.
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