Taxes on Flipped House

[davidfischer867]

I am finally doing my 2019 taxes and have a few questions on a house we have flipped. We bought the house in December of 2019 and it will sell this month (September 2020). My wife and I both have full time W2 jobs, so we just did this on the side.

1) When we go to do our 2020 taxes, what forms should we use for the sale?

2) Do we need to include anything on the house on our 2019 taxes since we purchased the house in 2019? We really didn't have any expenses in 2019 other than mortgage interest and property taxes.

Thanks!

[Anonymous]

If an investor is categorized by the IRS as a “dealer,” the profits from property flips will be taxed at their ordinary income tax rate. The profit is calculated by subtracting the expenses, including the purchase price, from the final selling price. Tax brackets range from 10% to 37% for “active investors” earning active profits.

According to the IRS, a real estate dealer purchases real estate and sells it to customers “in the ordinary course of his or her trade or business.” Most fix-and-flip investors are considered dealers; they hold their properties short term and the majority of their income is derived from flipping houses. Even real estate investors who occasionally flip houses are typically considered dealers and are taxed at ordinary income rates.

If you’re classified as a dealer, the profit from a flip will be taxed at your prevailing ordinary income rate. Currently, ordinary income tax rates range from 10% to 37%. In addition, the profit is subject to self-employment tax (the self-employed person’s equivalent to FICA), which is 15.3%, double what you typically pay as a W2 employee.

as a dealer the reporting will be on schedule c. technically you are in a partnership with your spouse.  but as long as the property was not held in an LLC there is an out to filing a partnership return.  if you qualify by not be an LLC you elect to be taxed as a qualified joint venture.  each of you files a schedule C to report your share of the profits or loss

A qualified joint venture is a joint venture that conducts a trade or business where:

The only members of the joint venture are a husband and wife who file a joint return.
Both spouses materially participate in the trade or business, and
both spouses elect not to be treated as a partnership.

Unfortunately, most of the home flipping expenses are not immediately tax deductible. Instead, they must be capitalized into (i.e. added to) the basis (the original value) of the property. Capitalized costs include:

The cost of the real estate itself
Direct materials
Direct labor
Utilities
Rent
Indirect labor
Equipment depreciation
Insurance
Production period interest (ie mortgage interest) 
Real estate taxes allocable to each project

[Anonymous_]

If this is a "one-off" (i.e., you are not planning to flip on a regular basis and it does not rise to the level of a trade or business), then you can report the transaction as a capital transaction (Form 8949/Schedule D).

The main issue here is, even if there is capital gain, the gain is short-term because you did not hold the property more than one year. As a result, you cannot take advantage of the long-term capital gain tax rate structure (although you can use capital losses to offset capital gain) but are subject to the ordinary income tax rates.

Regardless, you would avoid the self-employment tax on the net profit if the sale at a gain is reported as a capital gain.

[Carl]

@Anonymous 

We really didn't have any expenses in 2019 other than mortgage interest and property taxes.

Assuming nothing concerning this property was reported on the 2019 tax return, can one claim the mortgage interest and property taxes on the 2020 tax return as something like "carrying costs"? I seem to recall a scenario like this in the past on what would be (and this one will be also) a short term investment/gain.

[Hal_Al]

Q. Do we need to include anything on the house on our 2019 taxes since we purchased the house in 2019? We really didn't have any expenses in 2019 other than mortgage interest and property taxes.

Assuming this is an investment, and not a flip business (discussed in the other replies), you can deduct the real estate taxes on Schedule A (itemized deductions) for 2019 or add it to the cost basis when sold (special procedures required).  You may not deduct mortgage interest* on Schedule A (it is neither your primary or 2nd home, it's investment property) but you can add the interest to your cost basis.

  Real estate (property) tax may be deducted on schedule  A, under taxes, without regard to the old 2% rule.

Alternatively, taxpayers can elect to capitalize (add it to your cost basis)  the carrying costs of unimproved and nonproductive real property, real property under development or construction and personal property before its installation or use or sale (Regs. Sec. 1.266-1(b)(1)).  The election is made with the tax return by its due date, including extension, by attaching a statement. You cannot wait until you sell the property, but must make that election each year (2019 in your case). Attach the statement to the return and write “Filed pursuant to section 301.9100-2” on the statement. You may add the carrying costs, incurred in the year of sale (2020), directly to your cost basis. 

The carrying costs (repairs, insurance, utilities, etc   of investment property are not deductible, staring with tax year 2018. It's not clear whether those expenses can still be capitalized. Reference:

https://www.picpa.org/articles/cpa-now-blog/cpa-now/2020/02/19/consider-capitalizing-for-tax-breaks-...

*Mortgage interest is deductible, on Schedule A, as investment interest, but only to the extent of other investment income (unlikely for most people) and not subject to the old 2% of AGI rule,  but can be capitalized, as described above 

[Anonymous_]

The current issue with adding carrying charges to the cost basis, pursuant to Treas. Reg. §1.266-1(b)(1), is the charges must be "expressly deductible under the provisions of Subtitle A of the Code". 

Although there has generally been silence on this subject, after tax reform (the TCJA), miscellaneous itemized deductions are no longer deductible and, as such, should not (logically) fall within the carrying charges that can be added to the cost basis (i.e., chargeable to capital account). 

[1dayiwillgethere]

How do I handle the expenses when I spent a year (2020) fixing up the property and sold the property in another year say 2021?

Am I able to deduct any expenses on my 2020 taxes? If so how?

Thanks in advance for your reply.