Flip tax advantages?

Question

Keaton Vols · Answer

They will be done a few months apart from each other. I planned on living in one of them for at least two years because I want to move and to get the gains tax waived anyway. But if it meant saving me a good chunk of change I could live in the first one for two years while renting the other out to at least cover the mortgage. Then when two years are up move into the one that was being rented out and sell the one I was in.  @Aaron Zimmerman@Colin Muschik@Colleen F.

Michael Eskenasy · Answer

The mechanics of the §121 exclusion can work the way you’re describing, but one thing worth thinking about is intent.

The IRS generally looks at flips as business activity if the property was originally acquired with the intent to resell. If the project was clearly structured as a flip from the beginning, living in the property later doesn’t always convert that gain into primary-residence treatment the way people expect.

That’s why a lot of investors are careful about the distinction between:

• Dealer property (flips / inventory)

vs

• Investment or personal property

Living in the first one for two years could still make sense if you genuinely plan to use it as your primary residence and the numbers work with the longer hold. But if the original plan was two quick flips, the IRS sometimes views that differently than someone who bought a home primarily to live in.

Also worth running the numbers on the carry cost of holding each property for two years versus simply paying capital gains on a faster sale.

Definitely a good conversation to have with a CPA who works with investors, because the details of how the project was originally structured can matter quite a bit here.

Aaron Zimmerman · Answer

I'd definitely be talking this over with your cpa but it's certainly possible if you rent out. That said, if you rent the other one out and move in, you'll still have depreciation recapture to pay.

Dave Foster · Answer

I'm a big fan of tax-free!! @Keaton Vols, This can be a solid strategy to eliminate or minimize your tax. As long as you meet the requirements of the 121 exlclusion and lived in the property for two out of the previous five years of owning it as your primary residence. Not only will you get the 250/500K tax-free, but any remaining profit will be given capital gains treatment instead of ordinary income tax, as you'll pay now.  And I'm just guessing that if you live there yourself, the tenant (you) is going to take great care of the property to keep its value up.It sounds like your intent has been to sell these all along.  So the second property would not be a candidate for a 1031 exchange.  However, if you change your intent and decide to rent it out, you could then do a 1031 later with the same result - No tax.  It will just be indefinitely deferred.

Keaton Vols · Answer

@Michael Eskenasy Thanks for the input! Could you go more in depth on the "structured as a flip?" I took construction loans out on both. I did plan on living in one to begin with. I just don't want to lose out on the gains if it's preventable and I know this is an option.

Keaton Vols · Answer

Thanks for the input! Could you go more in depth on the "structured as a flip?" I took construction loans out on both. I did plan on living in one to begin with. I just don't want to lose out on the gains if it's preventable and I know this is an option.

Colleen F. · Answer

@Keaton Vols  are they both going to be done at the same time ?  And are you in an appreciating market? Because if there is a lag between completion of home 1 and home 2 it may make some sense but then you are looking for a renter that wants to stay a year or two to fill the gap while you are in home 1. Also you know what the market is today and not tomorrow so will if there is an volatility in the market consider that.

Bo Smith · Answer

The primary residence exemption (§121) is real, but the timing and execution matter more than you'd think. You can exclude 50k of gain if you're single, 00k if married, but IRS requires you actually lived there as your primary residence for 2 of the last 5 years before sale. Two flips side by side complicates this because you can only claim one as your primary at a time.

The scenario you're describing -- live in the first, then move to the second to reset the clock -- works mathematically but it's slow. You're looking at a 2-year hold on each property just to qualify for the exemption, which ties up cash and delays reinvestment. That only makes sense if the gains on each flip exceed 00k (married). If you're making 0-120k per flip, you're way under the exemption anyway, so carrying costs for 2 extra years kills the deal.

Better move: Run them both as rental income properties, hold them longer, hit depreciation and other tax benefits, or just accept the capital gains tax if the flip profit is reasonable. Pair that with a real CPA who understands flips (not a standard tax guy). The §1031 exchange is way more powerful if you're looking at tax deferral strategies.

What's the estimated profit on each flip before taxes? That'll actually drive whether it's worth the 2-year hold.

Colin Muschik · Answer

It seems the intent is to live in one property and not necessarily maximize profits. I think your correct in saying if you don't want to wait then your not going to get a "tax advantage" and will have to pay the tax on any gain. If you want a better tax answer then a two year period needs to pass regardless. Since the homes are flips you need to establish the use of property and typically 2 years is a enough to establish use to do a §1031. Based on the situation why do a temporary tax deferral strategy in form of a §1031 exchange when you can qualify for the home sale exclusion which is a permanent tax answer. The home sale exclusion is also a much easier strategy to execute then a §1031.

Flip tax advantages?

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