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Be careful -- real estate 'flips' can backfire

Be careful -- real estate 'flips' can backfire
By KAY BELL
BANKRATE.COM
Saturday, September 24, 2005

If you're looking to turn a quick buck on a real estate transaction, accountant Bill Rucci has some words of warning: "It may be quick, but it also may not be as lucrative as you first thought."

With housing prices in many parts of the United States skyrocketing, flipping -- buying a property and then quickly reselling it at a higher price -- has become the hottest investment trend.

But if you're not careful with your real estate flips, your investment strategy could produce a sizable payoff for an unintended partner: the Internal Revenue Service.

Rucci, a CPA and partner in the Boston-based accounting firm Rucci, Bardaro and Barrett, says that many of today's real estate investors go into the transactions completely uninformed.

"There is a huge misconception on the part of some people who think they can buy a residential home, not necessarily their personal residence, fix it up and then sell it and then get what we used to call the old rollover provisions where you used the money you made to buy another piece of property for more than what you sold," Rucci says.

But there are two problems with that approach. "One, that rule existed for personal residences only," Rucci says. "And two, it doesn't exist anymore."

The rollover rule was replaced in 1997 by current law, which allows, in many cases, for the tax-free sale of a personal property. This is a great tax break if you're selling your primary residence after having lived in it for several years, but it does nothing for you tax-wise if you're selling a house that you never lived in.

"The biggest issue with the real estate market, with the boom and prices rising very quickly, is that people want to capitalize on their gains, to take the money and run, so to speak," says Lonnie Davis, a CPA with the Philadelphia office of CBIZ Accounting, Tax and Advisory Services.

Instead of running, a tax-smart flipper could benefit from a slightly slower investment pace.

Investment profit, regardless of whether it comes from stock sales or real estate, is considered capital gain and is taxed at two levels. The tax rates depend on how long you own the property.

Hold an asset for a year or less and you'll face short-term gains that are taxed at ordinary income tax rates. This could be as high as 35 percent. If your investment timetable is lengthier, federal tax laws reward you.

But continual property flipping could create additional tax problems. When you complete several real estate transactions in a short time, don't be surprised to learn that the IRS might consider your property transactions as a business or trade rather than as an investment strategy, Davis says. In that case, there's no way to get out of paying the higher ordinary income tax rates.

But there are ways to pay less tax on a property-flip profit. The easiest is the aforementioned capital gains technique. Simply hang on to the property for more than a year, and you'll pay long-term capital gains taxes instead of higher ordinary rates.

Want to avoid taxes altogether? Move into the investment property and turn it into your primary residence. As long as you live there for two years (or a total of 730 days, and the occupation time doesn't have to be sequential) out of the past five, Davis says, the IRS will accept that it was your home. Then when you sell it, up to $250,000 (twice that if you're married and file jointly with your spouse) of your profit is excluded from taxation.


LINK: http://seattlepi.nwsource.com/money/242074_real24.html