Flipping Houses? Uncle Sam is Watching

Good article from The Real Estate Center By David Jones, Senior Editor,

COLLEGE STATION, Tex. (Real Estate Center) – Flipping houses is not as popular as it once was, but there is still money to be made at it. As with any profitable venture, flipping is on the Internal Revenue Service (IRS) radar.

“There was a substantial increase in flipping during 2014 in some areas of the country,” said Dr. Jerrold J. Stern, a research fellow with the Real Estate Center at Texas A&M University. “In the first quarter, Dallas and Houston flips were up 28 percent and 29 percent, respectively.”
Flipping is typically assumed to have taken place when a house is sold less than a year after it is purchased.
In August 2014, RealtyTrac reported flippers earned an average 21 percent gross return or $46,000 average profit. That was down from a peak of 31 percent in 2011.
“To a large extent, the tax treatment of flipping depends on whether the IRS considers the flipper to be a real estate dealer or a real estate investor. Investor status is generally preferred by flippers,” said Stern, an accounting professor in the Kelley School of Business at Indiana University.

“While the IRS uses a list of key factors to determine dealer-investor status for flippers, no single factor is determinative.”
The most important factor may be the number of flips per year, he said. One flip does not normally indicate dealer status. As the number rises, however, so does the possibility the IRS will classify the flipper as a dealer.
“Investor net income from properties held one year or less is considered short-term capital gain,” said Stern, “and generally taxed at ordinary income tax rates ranging from 10 to 39.6 percent. Such gains may be subject to an additional 3.8 percent investment income surtax depending on the level of the investor’s other taxable income.”
In sharp contrast, dealer net income is subject to the regular income tax plus the 15.3 percent self-employment tax but not the 3.8 percent investment income surtax. The holding period is not relevant. The 15.3 percent tax rate is applied to the first $118,500 of adjusted net self-employment income.
Dealers can deduct losses in full in the year of sale. Investors’ long- and short-term capital losses may be limited to $3,000 per year.
For more on flipping, including taxation examples, read “Flipping Houses? Uncle Sam is Watching” in the January issue of Tierra Grande magazine, the Center’s flagship periodical. 

Only thing I can add to this is…what in the heck is he NOT watching?