Is Real Estate Flipping Illegal?
Friday, February 08
Is real estate flipping illegal? This is an extremely misunderstood topic among investors, brand new and seasoned alike. Although I am not an attorney, I will lay out the facts. (Disclaimer: I am not providing legal advice in this article and for such advice on any legal related issues, always consult a qualified attorney). If you are (or are considering) real estate flipping, read this article start to finish. You are probably going to hear things you have never heard before and this may be quite different from what you have heard before. Flipping can be extremely profitable but real estate is highly regulated and the participants involved can be quite litigious as well, so you need to know what you are getting yourself into.
What is Real Estate Flipping
In order to get to the bottom of the legality of flipping, let's first define what it is. When you flip real property, you get it under contract for a low price and then resell it for a higher price within a short period of time. In some cases you may add improvements to the property but in other cases, you may not perform any repairs whatsoever and simply assign your interest in the real property to another investor.
Is it illegal to buy something at a low price and then resell it for a higher price to someone else? Some would argue that the art of buying at a low price and then reselling for a higher price (aka arbitrage) is capitalism. So surely it can't be illegal?
Constitution fans will preach the Constitutional right to the free alienation of property as the basis for why real estate flipping is 100% legal. When you own real property or simply have a contract to purchase real property, in either case, you have an equitable interest and therefore, have the constitutional right to resell that interest for a profit. But does this apply in all situations?
Where Real Estate Flipping May Be Illegal
Despite your Constitutional rights, each individual state has laws pertaining to real estate that may supersede federal rights. Here are a few examples, although by no means an exhaustive and complete list:
- Washington RCW 18.27 states that if a person or entity purchases real property and intends to add improvements in excess of $500 and then sell for a profit within 12 months, the owner must be a licensed and bonded general contractor. Notice it didn't say you had to hire one, it says you have to BE one. Ouch!
- Washington RCW 61.34 stipulates that buying and reselling real property for a profit from someone who is behind on mortgage payments and facing foreclosure may be considered equity skimming and therefore illegal. Although this particular law has more than one interpretation, the consensus among Washingtonian investors is to not engage in flipping pre-foreclosures.
- Maryland SB 761 defines most people who transact real estate with sellers in pre foreclosures as “foreclosure consultants” and foreclosure consultants must be licensed real estate agents, attorneys or mortgage brokers. Although there are some narrow exclusions, the consensus among non-licensed investors in Maryland is that flipping foreclosures is dicey and most steer clear.
These are but a few examples of when real estate flipping may be illegal. What others are out there? Please comment at the bottom on any examples from your state so we can all learn and benefit.
Real Estate Flipping Myths
Our right to freedom of speech has reached an entirely new level thanks to the internet. But it has also ushered in an era with more bad advice and inaccurate information than ever before. Here are some myths surrounding real estate flipping that pertain to this discussion.
Myth # 1 - 90 Day Flipping Rule
This is NOT a law. This is an underwriting stipulation put in place by some mortgage companies and/or certain mortgage loans that require the seller of a property to have been the owner of record for a minimum of 90 days. FHA loans are notorious for this requirement. Even though the ban has been lifted, most mortgage companies that originate FHA loans demand the seller be on title for at least 90 days. Thankfully for wise investors, this 90 day rule is not a big challenge because certain mortgage originators are not required to meet this stipulation. Despite what a mortgage broker may tell you, they are not all created equal and just because one mortgage person must meet the 90 day stipulation, doesn't mean they all must. Many, many investors have fallen victim to having their mortgage broker convince them that they MUST hold onto the property for 90 days before they can resell it. Nonsense!
Myth # 2 - You Must Have a Real Estate License
Every state has laws that describe what real estate income related activities legally require a real estate license. Most are very encompassing and can be intimidating to read, especially if you are a brand new non-licensed investor looking into real estate flipping. Thankfully, most states have an exception to their licensing requirements that sound something like Alaska Sec. 08.88.900: Exceptions. A person who is not licensed under this chapter who manages or makes a real estate transaction with respect to real estate the person owns or is seeking to own so long as the compensation the person receives does not include any portion of the commission or other compensation paid to a real estate licensee in the transaction. The key distinction is the part which distinguishes ownership AND the intent to own, as in having contract with the seller, as being an exclusion to the real estate license laws. This is an example of state law upholding your Constitutional right to the free alienation of property. However, as you learned in the previous section above, there may be situations, such as when a homeowner is in foreclosure, where state law can supersede federal rights.
Hopefully this article gives you a greater understanding of the legality of real estate flipping. If you are a flipper, or plan to be, it would be wise to consult a qualified, local, real estate attorney and ask him/her, "In what situations or scenarios is real estate flipping illegal?"