The Recent Tax Rules on Gains Realized From Flipping Houses- IRS 523
If you’re planning to flip your home, it would be best to check the latest IRS information when flipping a house. There are new rules about Capital Gains Tax, which are quite different from the previous Capital Gains Tax deferment rules. Whereas the old system precluded you from realizing gains if you will be flipping houses, IRS now allows you to realize gains if you will be selling a home you own and have occupied for at least two years.
The two-year residency does not have to be on a consecutive basis, as long as it can be established that you had lived in it for a total of 24 months for the past five years preceding the sale,
The new rule is, you can exclude gains realized from selling your house, up to $250,000 if you’re single, or up to $ 500,000 if you’re married, provided you and your spouse file joint income taxes. Any gains in excess of your tax exclusion benefit will be taxable as capital gains, and should be settled within 30 days from the date of sale.
However, it is important certain conditions are met, in order to maximize fully the tax exclusion benefit. The larger the tax exclusion benefit, the less or even zero gains will be taxable for flipping the home. There is also the prescriptive period before you can use the exclusion benefit for another round of house flipping, because you can claim it only once every two years.
Nevertheless, the new rules eliminated the old problem of having to look for a house that could serve and qualify as your “rollover residency”, which was part of the conditions of the previous capital gains tax deferment system. In case you’re not too familiar about the old system, it contained provisions wherein IRS prevented the house seller from realizing gains if the seller wanted his capital gains tax deferred.
The old tax deferment rules required the home seller to entrust the sales proceeds to an intermediary, usually the real estate agent. The intermediary was tasked to look for a new home for the seller; on the seller’s part, he had to buy a new home within a prescribed period. The sales proceeds which were held in trust by the intermediary were applied as payment for the newly acquired home.
It was important that the value of the new home was equivalent to the sales proceeds or even greater. Otherwise, any excess in sales proceeds was reported by the intermediary to the IRS as capital gains of the seller, for which the latter had to pay the equivalent capital gains taxes within 30 days.
Still, the new IRS information regarding flipping a house can be advantageous for those who own more than one property, since they can simply transfer residency after selling the main house. While in observance of the two-year restriction period, they can have the new home refurbished and ready for flipping. Thereafter, the homeowners can put up the property for sale, once the said prescriptive period had elapsed. In fact, the two-year restriction allows you to meet the two year residency requirement.
Conditions for Capital Gains Tax Exclusion when Selling a Home
- It is important that you are the owner of the house for at least two years in the past five years.
- You have made it your residence for two years before the sale was made. It can be based on a non-consecutive residency for as long as it totals 24 months during the most recent five years preceding the date of sale.
- This exclusion benefit will be used only after every two years.
Please proceed to the next page for information on how to compute the tax exclusion as well as other IRS information when flipping a house.
How to Compute the Capital Gains Tax Under the New Rule
Below are examples on how to calculate the capital gains tax to be paid, assuming that the amount of gains used in the example is already the net gain.
Example 1: Supposing you’re single and you sold your house and gained $ 275,000 from it. Your capital gains tax base is only $ 25,000, which is the difference between your actual gains of $275,000 less your tax exclusion of $ 250,000. Hence if the rate of capital gains tax is 15%, the amount of tax is computed by multiplying $ 25,000 x 15%, which is equivalent to only $ 3,750 for this property. This is quite minimal compared to the $ 250,000 you were allowed to retain as tax free gain.
Example 2: Using the same gain of $275,000 from example 1, you can exclude the entire gain as taxable income if you and your spouse have joint tax returns, inasmuch as the excluded amount allowable is up to $500,000. In this case, the entire $ 275,000 is tax free.
Example 3 : Now, if you are a co-owner to the house sold, and previously lived in the house sold with the other owner for two years within the five years immediately preceding the year the house was sold, you and the other co-owner can claim $250,000 each as entitlement to exclusion. Supposing your gain from the sale was for $300,000, it is presumed that this gain will be divided equally between you and your co-owner. Your exclusion will still be nil inasmuch as your share from the sale is only $150,000 as against your $250,000 entitlement as a single tax filer.
What if the House was Sold in Less than Two Years?
As a rule, tax exclusion is not applicable if any of the two-year criteria for ownership, residency, and interval is not met.
If you owned and occupied the house for less than two years, and had to sell it due to any of the valid reasons stipulated by the IRS, you can allocate a portion of your gain and exclude it, and then pay taxes only on the gain realized. This would be net of the exclusion you allocated for the number of months you actually resided in the house you sold.
The valid reasons that qualify a homeowner for reduced exclusion if the property was sold without meeting the two-year period conditions of ownership, residency, and interval are:(1) transfer of location due to change in employment, (2) health reasons, and (3) unforeseen or unavoidable circumstances.
Example 4: Using the $275, 000 gains realized from selling a home you owned and lived in for eight months, compute for the amount of exclusion by determining the proportion of the actual number of months you lived in the house over the required number of months for exclusion. That would be equated as 8 / 24 = 33.33%.
Use the resulting rate to determine your exclusion, multiply $ 250,000 by 33.33% if you’re single, and you’ll get the amount of $83,325 as your excluded gain; the difference between $275, 000 less $83,325 is $191,675 and this is your taxable gains.
If you’re married and filing tax jointly, multiply the allowable exclusion of $500,000 by 33.33%, and you’ll get the amount of $166,650 as your exclusion; the difference between $275,000 less $166,650 is $108,350, which is your taxable gains.
Please proceed to the last page for more IRS information when flipping a house.
What if a House is Simply Flipped as an Investment?
The scenario is different if you sell a property that was intended purely for investment or flipping purposes, wherein residency, ownership, or tax exclusion requirements are not considered. The entire amount realized as net gain from flipping the house is taxable.
To illustrate, let’s use the same realized gain of $275, 000 and multiply it by the capital gains tax rate of 15% for a result of a capital gains tax obligation amounting to $41,250.
This may seem like a simple procedure, and the tax due is still reasonable, considering the gains realized from flipping the property can be substantial.
What if Several Houses were Flipped Within a Taxable Year?
The IRS also looks into house flipping activities and distinguishes houses that were flipped from capital assets owned, or what one would call personal investments, from those that were flipped as part of business operations.
Flipping houses considered as capital assets of a taxpayer will be met with capital gains tax. Houses bought at low prices, refurbished, and then held mainly for selling purposes are not considered as capital assets, but as part of a business inventory. Gains, therefore, are considered business income.
IRS information when flipping a house provides that sale of capital assets, which include selling one’s home or a property held as capital asset or personal investment, earn capital gains. It will be reported as Capital Gains and Losses Schedule D of Form 1040. The maximum rate of capital gains tax is 15%, and is considered by IRS as generally lower than the income tax rate.
This means that in flipping houses, IRS will consider it unusual if you will be flipping several homes within a year, and report the income as capital gains. The regularity of your house-selling activities will be tantamount to selling investment properties as business operations; hence, you will be required to use IRS Form 4797 (Part III Gains and Disposition of Property,) and as opposed to capital gains tax, income realized from the business of selling real properties will be taxed at a higher rate.
Reference Materials and Images Credit Section
- https://www.irs.gov/pub/irs-pdf/p17.pdf —Publication 17 Federal Income Tax individual
- https://www.irs.gov/pub/irs-pdf/p523.pdf —Selling your Home
- https://www.irs.gov/pub/irs-pdf/p544.pdf —Sale and Other Disposition of Assets
- https://www.irs.gov/pub/irs-pdf/p550.pdf —- Investment Income and Expenses
- https://www.irs.gov/pub/irs-pdf/f4797.pdf — gain from disposition of property
- Wikimedia Commons