Flipping houses often starts with a simple plan. Buy a property, improve it, and sell once the work is complete. Many investors also assume that if the project takes long enough, the profit may qualify for long term capital gains or even allow for a 1031 Exchange.
That is where problems can begin.
David Moore and Tom Moore of Equity Advantage frequently see investors run into this issue. The assumption is that time determines tax treatment. But as David explains, timing is not what matters. What matters is your intent when you buy the property. If you purchase with the intent to resell, you may lose a significant tax advantage.
Flipping Houses and Ordinary Income Treatment
Many investors expect real estate profits to qualify for long term capital gains. That is often true for investment property held for appreciation or rental income. But flipping houses is treated differently.
If you buy a property with the intent to fix and resell it, the IRS generally treats that activity as a business. That means the profit is taxed as ordinary income instead of long term capital gains.
David explains that how long the project takes does not change the result. A renovation may take months or longer than expected, but the original intent still controls the tax treatment. If the property was held for resale, the income is treated as ordinary income.
This is where investors sometimes get caught off guard. A longer hold period does not automatically convert a flip into an investment. The IRS looks at why you bought the property in the first place.
If the plan was to buy, fix, and resell, the gain is typically taxed as ordinary income regardless of how long you held the property.
Flipping Houses Can Also Impact 1031 Exchange Eligibility
The tax consequences do not stop with ordinary income treatment. Flipping houses can also affect your ability to complete a 1031 Exchange.
David explains that when a property is purchased with the intent to resell, it generally does not qualify for a 1031 Exchange. Since the property was held for resale instead of investment, it usually does not meet the requirements for tax deferral.
This can be surprising. Some investors assume they can flip a property and then defer taxes through a 1031 Exchange. But if the property was held for resale, it is typically treated as inventory rather than investment property.
Once again, timing does not change the outcome. Holding the property longer does not restore eligibility. The determining factor is still your intention going in.
When Flipping Becomes a Business
For investors who want to flip properties regularly, Tom explains that the activity often makes more sense as a business from the beginning.
If the goal is to flip houses and create an ongoing operation, there may be a structure designed specifically for that approach. Tom describes using a rollover business startup, often referred to as a ROBS transaction.
This structure allows investors to use retirement funds to form a new corporation that operates as a flipping business.
How a ROBS Transaction Works
A rollover business startup, or ROBS transaction, creates a structure designed specifically for operating a flipping business using retirement funds.
The process begins by forming a new corporation. That corporation establishes a retirement plan, and retirement funds are rolled into the new plan.
Once the funds are inside the plan, the plan purchases shares in the corporation. This provides capital for the business to acquire and improve properties.
The corporation can then hire you as an employee. This allows you to actively participate in the business, including working on the property yourself or hiring contractors to complete the work.
With this structure in place, the activity aligns with the original intent. Instead of trying to treat flipping as an investment, the business is designed specifically for flipping properties from the start.
Consider the Tax Consequences Before Flipping Houses
Flipping houses can be an appealing investment strategy, especially for investors looking for shorter timelines and faster returns. But as David explains, the tax treatment can be very different from what many investors expect.
If you purchase a property with the intent to fix and resell, the profit is generally treated as ordinary income. The property also typically does not qualify for a 1031 Exchange. Even if the project takes longer than planned, holding the property longer usually does not change that result.
For investors who want to flip properties as an ongoing strategy, Tom points out that this activity may function more like a business. In those cases, a rollover business startup, or ROBS transaction, may allow investors to form a corporation, roll retirement funds into a plan, and hire themselves to work on the properties or hire contractors.
Flipping houses can still be a viable strategy, but understanding how intent affects tax treatment and 1031 Exchange eligibility can help you evaluate whether it aligns with your investment goals.
If you are considering flipping houses and want to understand how your intent may affect long term capital gains treatment or overall tax strategy, contact IRA Advantage to speak with an expert and determine the approach that best fits your investment goals.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
FAQs About How Flipping Houses Affects Taxes and 1031 Exchanges
Does flipping houses qualify for long term capital gains?
Generally, flipping houses does not qualify for long term capital gains treatment. If you purchase a property with the intent to fix and resell it, the IRS typically treats the activity as a business. This means the profit is usually taxed as ordinary income rather than long term capital gains, regardless of how long the renovation takes.
Can you do a 1031 Exchange after flipping a house?
In most cases, flipping a house does not qualify for a 1031 Exchange. Properties purchased with the intent to resell are typically considered inventory rather than investment property. Because of this, the IRS generally does not allow 1031 Exchange tax deferral when a property was held primarily for resale.
What if I want to flip houses as an ongoing investment strategy?
If you plan to flip houses regularly, the activity may function more like a business. In those situations, a rollover business startup, or ROBS transaction, may allow you to form a corporation, roll retirement funds into a plan, and hire yourself to work on properties or hire contractors. This structure aligns the activity with an ongoing flipping strategy.
