Real estate "flips" require some finesse.
Flipping houses is one of the most misunderstood real estate investment strategies. The "flip" can be financially rewarding as long as the investor is organized, takes certain precautions to guard against added tax liabilities and times their investment to avoid unnecessary expenses.
Establish a Business Entity
Establish a separate legal entity, such as an LLC, in which to transact business if you are going to flip properties. Investors who purchase properties and then "flip" or sell them within a year run the risk of being deemed a "dealer in real estate" by the Internal Revenue Service (IRS). Other factors, such as the number of homes you sell during the year and your intent when purchasing a property, may be taken into consideration by the IRS. This "dealer" designation will make you liable to pay federal income taxes as high as 35 percent and state income taxes, as well as self-employment tax at 15.3 percent on your profit. You also lose the tax deductions available to real estate investors because the profit from your transactions are considered income from a business or trade. If you are holding additional real estate for long-term appreciation, those properties should be held in a separate entity or your own name.
Locate Funding
Seek funds, either through your own assets, other investors or a hard money lender so that you can pay cash for the property and compete with other cash buyers for the best bargains. Hard money lenders lend on the value of a property and not your credit score. They will usually lend up to 65 percent of the current market value of a property for a period up to three years, with points and a higher interest rate than you would expect with longer-term financing. Bank- owned properties are routinely sold in blocks to big investors who turn around and sell the individual properties at wholesale prices. You will not be competitive if you are relying on a conventional loan to close the deal because time is money to the sellers. You need to be able to purchase a property at a deep enough discount to sell it for a profit to the next buyer. This is often 40 percent or more below market value. If you choose to "fix and flip" a property, your expenses will be higher due to repair costs, and you will need to sell to a retail buyer to make a profit.
Inspection and Offer
Inspection of the house should be done by someone skilled in detecting structural problems. Due to the competitive nature of deeply discounted homes, the inspection should be done as soon as possible. If the home appears structurally sound and there are not too many cumulative problems with the electrical, plumbing, heating, and sewage systems, then a contract to purchase should be submitted along with earnest money to the seller. If the contract is accepted, paperwork is sent to a title company for closing. Some states may require an attorney to close the property in escrow.
Execute the Flip
Clean up the property as quickly as you can after your cash deal closes, then put the home on the market at a reasonable discount to move it quickly. Flippers usually take a proactive approach to marketing and contact other investors. The major challenge to flipping is the ability to negotiate a low purchase price and then sell the property quickly for a profit, despite the heavy tax burden. Because investors who flip properties do not generate rental income during their holding period, time is of the essence. Deciding when and if to make repairs beyond the initial cleanup is an investment decision best made quickly. Although there is no time limit, holding a property for more than a year reduces the tax liability, makes the home eligible for a 1031 exchange and, again, has some bearing as to the entity in which the investor may chose to hold title at the time of the property's sale.
Tags: flip properties, income taxes, market value, other investors, property quickly, property your
