What Every Investor Needs To Know About Flipping Houses (That No One EVER Talks About)

10

If you flip houses then you are more than likely all too familiar with the process.

First you have to find and buy the home you think has the most potential, then renovate it, and finally put it up for sale. The primary goal of flipping real estate is to purchase, renovate and sell the investment as quickly as possible while receiving the biggest profit you can.

As a CPA, I work with a variety of investors.

Some buy, hold and rent their investment properties, while others decide to buy, improve and sell. Personally for me I don’t have the knowledge, time, or stomach for fix and flips.

Don’t get me wrong…..this doesn’t mean that I don’t see the huge profits that some of my clients are making in this lucrative business. With the large profits of the flipping businesses within the past few years, we are meeting with more and more clients who are flipping real estate on a full-time basis.

When you buy and flip a property it is vital to have an understanding of what tax liabilities you may be facing. Uncle Sam always wants a piece of the action so be ready for him to take a share in your profits. You can be taxed on the state and federal level and even subject to self-employment taxes. A whopping 25% to 55% can be Uncle Sam’s share if you are not careful.

Below are some suggestions and considerations you can use to maximize your profits from your real estate flips while minimizing your tax liability.

Forming a Legal Entity

If you are actively flipping properties then it is important for you to consider forming an entity to provide you with both asset protection and tax savings.

Related: Top 3 Real Estate LLC Myths: Busted!

If you form an entity, it might protect you from being held personally liable in the event that there is business debt or any lawsuits arise.

In addition, using the right legal entities can help you to significantly reduce your self-employment taxes. Using the Limited Partner structure or the dividend/salary split strategies of an S Corp can help to shave a large chunk of self-employment taxes from your tax bill.

Get Licensed

Working with a real estate agent or broker no doubt has its benefits, but keep in mind you are paying for it.

For example, if you sell a property for $500,000, the sales commission for your broker or agent can be upwards of $25,000. That’s $25,000 out of your bottom line. Getting licensed can help you to preserve your profits on every deal that you do.

Get Your Numbers Right

I once met a gentleman who told me that he had a flourishing flipping business with over $4.5M in assets under his management, mostly comprised of family and friend money that were used as loans to fund his flipping business.

After we looked at his poorly constructed financials, we found out that not only was he not making as much as he thought he was, he was actually losing money on more than half of his deals.

By not having accurate financials, he was not able to see how much he profited or lost on each flip property. With excess investor funds in the bank, this flipper had a false sense of profit for his company when in reality he was merely tapping into investor funds.

Cash can be tight, especially for a fix and flip business. Make sure to get monthly and accurate financials done to keep a tight grasp on the income and expenses of the rehab projects and make adjustments as needed.

The number one bookkeeping tip I would give is to make sure that you are tracking income and expenses by property. Having reports by property is vital to the financial health of your flip business.

1099 Your Contractors

No one likes to pay taxes and that is the same for a lot of contractors.

What a lot of flippers may not know is that it is the responsibility of the payer to issue 1099s to the people you pay. Believe it or not, if you ever get audited and the IRS finds out that you did not issue the required 1099s to your contractors, they may hold you responsible for paying the taxes on behalf of your contractors.

The safest thing for you to do is to simply get the paperwork from your contractor and issue them the required 1099s where appropriate.

Have you ever paid a contractor during the year and then went to them at tax time the next year to try to get their social security number to issue a 1099? If you did, chances are high that the contractor either didn’t respond or simply laughed in your face. After all, who wants to pay taxes?

If this sounds like you, here is a tip. As part of the contract for a rehab job, make sure to have your contractors fill out Form W-9. This form will provide you with their signature and all the relevant information you may need if a 1099 is to be issued.

Even if it turns out that you did not need to issue a 1099 to this contractor, keeping this W-9 in your records can help to protect you in case of future audits.

Related: Who Needs a 1099?

Don’t Forget about Retirement Funds

If you have a flipping business and you (and your spouse) are the only full time employees, then consider setting up a Solo K to redirect tax dollars into retirement accounts.

The contributions you make can reduce both state and federal income tax even for those who are self-employed. Depending on your net profit from the flipping activities, it is possible to put away $50k or more per person per year into a SoloK account and significantly reduce your tax bill.

The best part of all of this is that the money within your retirement account can be used for other real estate deals. If you are paying a private lender 12% to fund your rehabs, consider using your retirement money as a private lender in someone else’s deal to generate some high interest income.  Just remember that your retirement money cannot invest in deals that you already own or that you are actively participating in.

One common mistake that I see time and time again is with investors who are too busy running their flip business to take the time needed to tend to the financial well-being of their business.

Remember, it’s not about how much money you make, it’s about how much money you get to keep, so take the time to make sure that you are doing what you can to keep more of your bottom line.

What are some of the things you do to protect your money while fixing and flipping houses?

Be sure to leave your comments below!

Subscribe to our mailing list

* indicates required Email Address * First Name Last Name
Share.

About Author

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

10 Comments

  1. Amanda, thanks for the timely article. A new real estate investor who intends to start wholesaling and flipping properties asked me about setting up an entity, and I suggested he first talk with a CPA to determine which form of entity would be the best for his business model. Is there a different recommendation if the flipper turns 1 – 2 properties a year as compared to 5 – 6 properties? Also, I heard of someone who formed a LLC, chose the Corporation option, then had the LLC – Corporation take the S-Corp election. Seems complicated, but they wanted to avoid the self-employment tax. Can you comment?

  2. What happens if you never heard of a 1099 until today, and never issued one ever. (2 years buy and hold investing & lots of reno expenses…)

  3. Excellent post! Everything financial very succinctly laid out in an easy to understand manner. I will be bookmarking to refer to until this is second nature. Thanks!

  4. Hi Amanda! Can you confirm this statement for me:

    “Just remember that your retirement money cannot invest in deals that you already own or that you are actively participating in.”

    I had a Solo 401K provider tell me that you could take a loan from your Solo and use it to invest in anything you wanted (even your own deals), as long as you paid it back in five years and all gains/profits go back to the Solo. Did I misunderstand him?

    • Sharon, your 401k can not invest in the deal, but you can borrow the money from your 401k and invest it in the deal, as long as your total of loans is less than $50k and is no more than 50% of the 401k total funds. There are a few other considerations once you have taken out loans.

      • And the profits don’t go into the 401k, unless the business that holds the 401k deposits them as you normally would. You pay interest on the loan just like to any other lender, and that is what must go back in. You have to pay at least prime +1%. You also must pay regular payments, on time, or the loan becomes an early distribution.

  5. Having Uncle Sam as a silent partner is the reason why I don’t like flipping, mostly buy and hold. I keep a property for at least 1 year and a day before I sell which is rare for me. All my rentals are cash flow positive, why would I want to sell the golden egg for?

  6. @AmandaHan Great job on the article! It is super rare for people to be informed of the “Solo K” plans. It could be a great choice for certain people.

Leave A Reply

css.php