House flipping is hot -- to the point where more than one successful reality TV show has been created to feed the appetite of up and coming house flippers. But does the reality of house flipping measure up to the hype?
House flipping TV shows have met with huge success because they speak to many homeowners' aspirations to make it big in one of the few areas they have some control over. "Buy it cheap, fix it up, and then resell it for a large profit", sounds like something anyone who can "work smart" is capable of doing.
But there are problems. One of the big ones is that do-it-yourself renovators often do not realize the renovations they plan to do require permits and inspections. In some cases their renovations can be halted by unhappy neighbors disturbed by the noise and unusual activity next door.
Flipping hype also leaves an unrealistic impression about the amount and complexity of the renovation work required in order to make a significant profit from a resale. Real estate experts claim there is simply no way a house can be improved enough in two or three weeks to bring in $50,000 or $75,000 above the original purchase price.
Flipping accounting is also pretty suspicious. We've all seen those less-than-$2000 renovations completely transform a home on TV. But the reality is that real renovations often cost much more than these shows lead us to believe.
Profit calculations made by flipping hypesters often leave out some pretty crucial information too. Simply subtracting the final selling price from the initial purchase price may look impressive at first. But this often completely ignores the full costs of renovation, permits and inspections, not to mention real estate agent fees, legal fees, and taxes.
**Don't Ignore House Flipping Tax Issues
If you're thinking of doing some house flipping, be prepared to wrestle with some pretty serious tax issues. The general impression of house flipping (buying cheap, renovating, and selling quickly for a profit) is that your average person can turn a hefty profit without having to worry about the tax man. But the truth is, in the U.S. and in many other countries, profit made on selling houses is taxable income unless it is your primary residence.
According to Bill Rucci, a CPA specializing in real estate investing, many real estate investors are completely uninformed. "There is a huge misconception on the part of some people who think they can buy a residential home, not necessarily their personal residence, fix it up and then sell it and then get what we used to call the old rollover provisions where you use the money you made to buy another piece of property for more than what you sold," says Rucci.
But according to Rucci this only used to apply to personal residences. But more importantly, these regulations no longer apply even in those cases. They have been replaced by more sophisticated, more restrictive legislation.
Current IRS legislation makes a distinction between owning a home as a personal residence, and owning a property for investment purposes. In order to qualify as a personal residence, you must live in a house for at least 730 days (2 years) over the last five year period. In that case, profits made on a sale after the 2 year residence period are tax free on up to $250,000 profit.
But if you own a home for investment purposes (as most would-be house flippers do), and do not actually live in it, you could pay as much as 35% on the profits. Hold it for more than a year and the IRS will consider it a longer term investment. In that case profits will be taxed at the long-term capital gains rate which, in most cases, is a maximum of 15 percent.
Either way, it is pretty clear that the IRS does not look kindly on house flipping.