Discussion:House Flipping - Business or Investment?
From TaxAlmanac
Discussion Forum Index --> Tax Questions --> House Flipping - Business or Investment?
| 9 March 2007 | |
| By house flipping I mean buying a house, making repairs, painting the walls, replacing some carpet, etc, and then putting the house on the market. To clarify further, the client has a full-time job and is doing this in his spare time.
Would you file that as a Schedule C business or as a Schedule D gain? If a person bought and sold several houses during the year, I would go with Schedule C, but what if there has been only one house so far (that has not actually been sold yet) and the client may or may not do this again? | |
| 10 March 2007 | |
| I just had this issue with a client. I think the real key is intent: does the taxpayer intend to roll the property(s) to make a profit (business), or hold them with the hope that over time they will increase in value (investment)? You might be able to justify one property here and there on a Sch D, but I believe it is a red flag for the IRS to see several properties sold each year reported on a Sch D instead of a Sch C. I laid both sides out for my client, because much of the basis for which direction to go here rests in how conservative you and your client are - how comfortable are you with taking an aggressive stance? | |
| 10 March 2007 | |
| If client is getting into this business, Schedule C. If client is going to do one of these every couple of years, I would say Schedule D.
Of course the absolute correct way is Schedule C if his intent is to flip . . . | |
| 10 March 2007 | |
| In one of the earlier "flipping" cases, the Tax Court ruled that an airline captain could not use the fact that he had a full time job to prove that he did not have a trade or business. The Tax Court has also rejected to what the court refers to as the "one bite" defense. In other words, the Tax Court doesn't believe that you can be a little bit of a flipper just because you flip only once -- it is all or nothing. | |
| 29 March 2007 | |
| I've been reading through various discussions concerning flipping houses, and I can't help but think that I'm overlooking something.
If a TP starts an LLC (SM, taxed as Sole Prop) with the intent of purchasing and rehab'ing houses, but the holding period is across 2 or more tax years, what dictates what should be capitalized and what should be expensed? Some of the discussions indicate that UNICAP applies, some seem to suggest that it doesn't. Some say to capitalize improvements and expense items like taxes and interest. In the absence of a crystal ball, I am guessing that the TP will continue to flip houses, one at a time. Of course, he could decide this just isn't for him. I'm thinking that I'd like to capitalize as much as possible to offset the gain when the property sells. This is his first property, so there is no income, and I would rather delay the expenses to reduce the gain when he sells. | |
| 29 March 2007 | |
| On fix and flip: Standard case: Gartrell & Gartrell 619 F2d 1150 (1980). [A lot of times your county courthouse will have a law library the public can use]. Other cases are basically all over the place: M.W. Enslin TC Memo 1982-430 (1982) a case IRS will likely pull out if they are in a bad mood; RL Hamilton TC Memo 1973-93 (1973) more positive for TP treating as investment. There is a code section that addresses developers: IRC 1237.
Bigger picture: the speculative real estate game ended about 3 weeks ago. | |
Death&Taxes (talk|edits) said: | 29 March 2007 |
| We've got a couple of waterfront ones down here, asking 2.8 million, that have been vacant since being finished last year. If another summer goes by, these people won't be flippers but rather sinkers. | |
| 29 March 2007 | |
| Yup, D&T, and then the folks find out just what a personal guarantee is; and the fact that the new BR law ain't as generous as it once was. | |
| 29 March 2007 | |
| Thanks for the references. I will try to look into the cases. However, I don't think that IRC 1237 would apply since that is for subdividing RE and developers, neither of which apply here. What was different with this TP than the other discussions I've read is that he formally forned an LLC to do this work, so it is a business.
As for the housing market, I understand what you're saying D&T, but there is an alternative view that says the growing foreclosure scene is good for buying houses in a distressed situation and still being able to sell in this type of market. I fear we will be seeing more house flippers, not less. | |
| 29 March 2007 | |
| I suggest your client seek a tax professional experienced in working with real estate issues. The difference betweeen an investor and dealer is a very complicated issue. The information you provided is not sufficient to give any real advise. | |
| 15 March 2008 | |
| what about operating expenses such as utilities, insurance, etc while you have the house that you bought for investment. Where do you deduct them?
Neil | |
| 15 March 2008 | |
| It depends on the specific circumstances, dealer vs investor issues are key. You should seek a tax advisor experienced in these areas. | |
| 17 March 2008 | |
| I'll bet if saw TWO tax advisors, you might even get two different answers. I assume you've read the discussions here and elsewhere, so you probably have figured out that this is a gray area. If I recall correctly, there was a discussion that broke it down into operating expenses and capitalized expenses, and utilities fell under operating, but insurance fell under capitalized. However, I can't recall for sure, and I'll bet you could make the argument to capitalize them all. | |
| 17 March 2008 | |
| For a true investor, they would capitalize all expenses and offset any sales with them to decrease capital gains. However, the key is the determination of investor. Did they move any dirt? How many flips have they done. One is investor but 20 is probably not. Many issues with this determination including intent. | |
| 18 March 2008 | |
| A true investor (only bought 1 or 2 a year. so you are saying the while the house (investment) is sitting waiting for a buyer to buy it, the insurance, utilities, maintenance, etc must be capitalized??
Can't the property taxes be deducted in year paid and interest deducted currently against investment income? Neil | |
| 18 March 2008 | |
| If he is doing 1 or 2 a year over several years, the IRS will probably classify him as a dealer rather than investor. The houses in his hands would be inventory, gain would be ordinary and taxable by social security as earned income, holding costs during construction period (interest, property taxes, etc) would be capitalized under construction, and selling and holding costs during sales period (after construction is complete and certificate of occupancy is obtained) would be deductible. | |
| 20 March 2008 | |
| No bought only one house can't sell but spends money for maintenance such as utilities, insurance, etc. I understand these costs are capitalized and increases basis. Does owner get to depreciate since it is investment property | |
| 20 March 2008 | |
| NeilCPA, please consider taking some classes and CPE on taxation, seriously. NO. | |
| 24 March 2008 | |
| Really guys, that's pretty rude. The purpose of this forum is so that we can pick each other's brain. We can't all be experts in every area.
Gail | |
| 24 March 2008 | |
| nshnider,
you can only depreciate items that are in business use. What business is the house involved in? It's not. It is either an investment(similar to stock) or it is on sch C and is inventory . Either way, not depreciable. | |
| 24 March 2008 | |
| You don't want to depreciate it, becasue then it becomes a business expense. This is a topic that they really are looking at. I think that if there is only one say, I would do it as investment on Sehedule D. | |
| 24 March 2008 | |
| Gail, when one obviously can't handle a tax issue, reading a post on the internet is NOT enough to turn then into a professional preparer. In this instance, which you only see part of in this thread because other questions were being asked in other threads, Neil was obviously WAY over his head. The advice for a CPA and accounting professor to take some tax CPE was not rude, but obviously necessary, as he may have had lots of theoretical academic knowledge, but needed additional education in practical tax application. From the tone of his COLLECTIVE questions, not from the tone of this one, I had surmised that this CPA needed to go back to school before attempting complex tax returns. | |
- Posts from a non-tax-pro, and related responses, have been transferred here.
| 18 September 2008 | |
| If someone does house flipping as a business and files schedule C my understanding is that any houses not yet sold on the last day of the year is considered his inventory, which is not particularly applicable to form itself because there is no balance sheet component to schedule C.
My question, is if the taxpayer has several mortgages on the various properties can all the 1098's be added up and entered as mortgage interest expense or does the various 1098's need to be allocated to the individual properties and perhaps only deduct interest expense on the ones that were sold during the year and deferring the interest expense on properties not yet sold on Dec. 31. My original thinking was that since the taxpayer (my client) is doing this business as his full time occupation and this is being reported as ordinary self employed income (not capital gain) that all interest paid during the year should be deductable and it should not make a difference if the actual property was sold or not. I was hoping to get some feedback. Thanks. | |
| 18 September 2008 | |
| Jay - when you searched, did you read this discussion? Good feedback there on the interest question. | |
| 18 September 2008 | |
| Jay, you would capitalize the interest on the unsold houses. | |
| 18 September 2008 | |
| Trillium: Thanks for the link to the other discussion which directly relates to my question.
Kevinh5: It seems from the other discussion that Trillium referred me to that the interest on the purchase of the property would actually be deductable currently (even if not sold) and only the interest related to the "fix up" would be capitalized. | |
| 18 September 2008 | |
| of course it was also me in the other discussion advocating capitalizing it
I can see where 'holding' interest is different than 'construction interest', with a different answer for each. | |
| 18 September 2008 | |
| People see what they want to see, I guess. I thought that was a good discussion to link to because it had two new viewpoints (Kevin’s capitalize in construction period, Ramcfo’s expense if not fix-up-related) to add to Larry0434’s above (capitalize all in construction period, expense in selling period) – Jay passed right over yours and focused on the other…
Jay, I will defer to Kevin, Larry, and Ram for the technical determination, but I will point out that even if it flies, there may be a long-term downside to the short-cut you want to take (i.e., not accounting for each property's mortgage separately). If the business carries on at its current pace, you'll maybe always have that pool of mortgage interest to take against any given future year's profits, but what are you going to do in a year with lots of sales and little interest expense? | |
| 18 September 2008 | |
| To be honest, I actually did read the various views on the matter but I got excited when I saw someone mention the view I was hoping for.
However, you raise a good question. The current situation is that all properties are bought with mortgages and therefore there is always interest expense and they are all short term. Therefore, If the business continues in the same fashion, I do not think it should be a problem. I did have one other question. Someone mentioned about the mortgage interest being included in COGS. Would that only be I doallocate the interest to the property but if I deduct all interest I would put it below in expenses? Net profit is the same but just wondering if one is more correct? Thanks for all your help - This is a great website. | |
