Real estate agent buying a property, renovating and selling it — tax implications?

NoNickname asked:

Here’s the details – - real estate agent buys a residence. He/she pays for repairs and improves the property. Then he/she sells it for a gain/profit.

Tax implications? Isn’t there a rule out there regarding an real estate professional conducting a “business” in which he/she flips houses. Hope my details are not confusing.

Comments (3) Posted in United States

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3 Responses to 'Real estate agent buying a property, renovating and selling it — tax implications?'

ninasgramma - February 3rd, 2010 at 12:24 am
The fact that the person also works as a real estate agent does not affect the taxes on the house flipping.

If the person does the house flipping as a profit-making profession, then the houses become inventory, not capital assets. The profit from the houses after deducting all improvements (including cosmetic improvements) is the gross profit for purposes of Schedule C.

After deducting Schedule C Part II expenses related to searching for the houses, advertising, mileage etc., and perhaps the office in home deduction, the net profit is subject to ordinary income tax, plus self-employment taxes.

However, if the person occasionally flips a house as an investment, then the basis of the house is the cost plus improvements (not just cosmetic improvements, but capital improvements), and the gain is short-term capital gain taxed as ordinary income and reported on Schedule D. There would be no self-employment taxes to pay, but also there would not be the deductions that are available on Schedule C.
Charlie & Angie G - February 3rd, 2010 at 5:52 pm
If this is his home and he lives there at least 2 of the last 5 years then the profit is tax free.

If it is just an investment then the profit is reported on Schedule D, if owned longer than a year he gets the lower capital gains rate maximum 15%

If he is in the business of fixing up houses and selling them then the profit would be reported on Schedule C and he would have to pay self employment taxes.

If he is a real estate agent then he will report his commission on Schedule C and then one of the 3 options if just explained. I have know of no special rule that says real estate agents must report flips on their Schedule C, but that I don’t do many returns for real estate agents.
mahal - February 5th, 2010 at 12:07 am
This is a pretty complex question and would be difficult to answer here. Charlie and Angie G gave about as good and clear an answer as you can hope for.

I have heard of special rules for real estate developers, so I’ll add something here about that…

Real estate developers are:
1) People who spend more than 750 hours per year working at developing real estate
2) People with 50% or more of income from services derived from real estate development
3) Material participation is required (you can’t pay someone else to do it and then call yourself a developer)

This is how you define whether you are in the business of being a real estate developer. These rules apply to people who want to claim losses against their income and don’t want to be trapped in the rules regarding “passive income”. Rules #1/2 include these activities: development, construction, acquisition, conversion, rental, operations, management, brokerage, and leasing.

I would suggest to real estate agents who wish to be “flippers” set up a seperate LLC to handle that activity. Then the LLC can be the developer, and the agent can go about whatever other activity they want.