Don't Mess With Taxes

Residential real estate is still in the dumps, but that's not deterring some buyers.

However, these aren't folks who are looking for a bargain on a house into which they can settle.

Rather, they are real estate flippers, who pick up distressed properties for a song, fix them up and turn a nice profit when they resell, or in real estate parlance flip them.

Sounds like those late-night cable TV ads on how to get rich buying real estate, right? But flipping has always been an investment option.

And now a new breed of real estate flippers has jumped into the housing market thanks to the abundance of low-price properties. Banks are unloading huge portfolios of foreclosed properties, keeping house prices very cheap.

But the big difference nowadays, says a report today on NPR's Sunday Weekend Edition program, is that the flipping buyers -- that's the accurate description, not a euphemistic editorial comment! -- are putting up cash for the homes.

Cash sales have taken off, says the radio story, because banks have tightened lending standards, leading to the issuance of fewer mortgages.

House flippers today get the dough to buy the properties outright from investors who bankroll them. If the houses don't sell quickly, then the new investor owners turn them into rentals.

One such house flipper interviewed by NPR says he may spend close to $100,000 renovating a house he bought for $63,000. He thinks (hopes) he can flip it for $250,000. But even if it doesn't, the investor says "the market could literally correct itself $50- or $60,000, and we would still break even."

Good for that guy and his flipping colleagues. However, I still get a bit queasy when I think of folks trying to make money off of housing. I mean, isn't that what led to subprime mortgages, inflated home valuations and eventually the housing bubble that brought down the whole U.S. economy?

I'm not saying folks who flip real estate are going to get us into another mess. As I noted, this is not a new investment strategy.

But I am keeping my fingers crossed that extreme and unchecked greed doesn't take over again.

Remember the tax costs: If you're interested in flipping real estate, remember that the IRS will get a piece of your profit.

Even though you're buying residential real estate, when you sell a house that's not your primary home, you won't get the $250,000 (or $500,000 if you're a married, joint filing couple) tax exemption on your sale profit.

Anything you make on the sale of the investment property will be taxed at capital gain rates.

If you can flip the house quickly, say a year or less, you'll owe taxes at your ordinary tax rate. Right now, that could be as much as 35 percent.

Unless Congress acts in the next few months, that top tax rate will go up on Jan. 1, 2011, to 39.6 percent. Keep that time factor in mind if you're just now buying a house you hope to flip.

If, however, you hold onto the house for more than a year, then you'll pay long-term capital gains rate on your profit. That is, right now, 15 percent for most investors.

But that tax rate is set to go to 20 percent on, you got it, Jan. 1, 2011. Of it could go higher next year, depending on what Congress does.

Again, taxes shouldn't be your only or primary concern when investing, be it real estate or equities.

But neither should you ignore the tax implications of your investment moves.

So if you're looking at getting into the house flipping business, make sure you take any potential tax bill into account.

Related posts:

• The complete costs of house flipping
• Our flipping new neighbor
• News flash: Investing in real estate is risky
• Placing the blame for the subprime crisis
• IRS could have prevented subprime mess
• Subprime lending, brought to you by Texas
• Foreclosure's costly tax implications
• Foreclosure's other tax cost
• Hot new housing trend: Renting
  
• Economy killing home tax break, redux
• Did the home sale tax exclusion kill the economy?
• Tax policy and the American homeownership dream
• The unfairness of housing tax breaks?
• Is it time to kill the mortgage interest tax deduction? 
• Mortgage interest deduction madness

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