One episode of a house-flipping reality show doesn’t turn potential house flippers into experts. It takes months to years to learn the home flipping process and the business behind it. Even experienced house flippers go through net loss, nightmare renovations, and unruly buyers. However, there are glimmers of hope in house flipping that is controllable. One is finding friendly cities and states for house flipping. The other is not giving the IRS more money than required.
House Flippers Welcome
It’s always best to start home flipping in your area to get hands-on experience. However, if you are ready to move to the next step away from local house flipping, two reliable sources will help determine which places are suitable for house flipping success.
CNBC chose the best and worst states for house flipping. Their criteria suggest Tennessee, Colorado, Louisiana, Pennsylvania, and New Jersey are the flip-friendly five with Maryland, Florida, Virginia, Kentucky, and Illinois in the top 10. Except for Colorado, all are on the eastern side of the USA.
The worst states for house flipping are Mississippi, Montana, South Dakota, Wyoming, and Hawaii. Three states are open space areas with few residents across the state. Mississippi doesn’t have enough high-income residents to pay for flip homes, and Hawaii is losing residents due to its expensive cost of living.
WalletHub sees things differently from CNBC with their criteria. By studying 172 housing markets across the country, they believe five cities are the best cities for house flipping. They feel Sioux Falls, South Dakota, Rapid City, South Dakota, Missoula, Montana, Billings, Montana, and Peoria, Arizona are the top five. Tampa, Florida, Fort Smith, Arkansas, Greensboro, North Carolina, Las Cruces, New Mexico, and Boise, Idaho round out the top 10. Shockingly, the answers contradict CNBC’s choices; seven out of 10 cities are located in the western US.
The worst states for house flipping are San Francisco, California, Oakland, California, Newark, New Jersey, Yonkers, New York, and Bridgeport, Connecticut. The first four cities listed are too expensive for the average person to live, much less buy a home. Bridgeport is more affordable to live in than the others, but the real estate market is the most expensive purchase in the city.
Self-Directed IRAs
To take part in house flipping, use a self-directed IRA. The IRA uses check writing from a retirement savings account to handle real estate transactions without permission from an IRA custodian. Because the person who opens the account owns the account too, the person can purchase, remodel/renovate, and sell the property. Additionally, the money made is tax free.
Do House Flippers Pay Taxes?
Just because the money is free doesn’t mean house flippers are free from tax responsibility. Flippers must learn about the Unrelated Business Taxable Income or UBTI. Also called UBIT, the surrounding rules inform tax-exempt or tax-free areas of business that when leverage or business activities are active, the tax is active. Filed under for-profit business, the taxable income divide into trade/business, regularly carried on, and unrelated. It’s important to know the three components because any of them can trigger the tax.
Trade or Business – The IRS determines a “trade or business” as a profit-oriented business, including the tax-exempt businesses.
Regularly Carried On – The UBTI or UBIT rules come into play when a business or unrelated trade has income that is ‘regularly carried on.’ Analyzing what tax-exempt businesses do with a non-tax exempt business is mandatory to ensure no commercial-related transactions are happening. Examples are a tax-exempt business engaging in a manufacturing plant, store, or restaurant on the side.
Unrelated – An IRA or 401(k) is in the unrelated category if the transactions do not fit the regularly carried on rules. Examples are bank-generated interest and dividends, rental income, capital gains, royalties, and IRS-approved passive income.
So, what transactions trigger the UBTI or UBIT tax? The IRS follows preset guidelines to determine if the total houses flipped in a year or a certain transaction type will trigger the tax. The IRS relies on frequency, intention, and activity patterns to help out. If flippers must pay the tax, it currently stands at 37% of income.
• Frequency – The IRS will learn the total home flipping transactions completed in one year.
• Intention – The IRS will ask whether this is an active trade or business.
• Activity Patterns – Besides house flipping, the IRS will dig into the IRA account’s other activities. The answer will help them decide on whether this is a business activity or an investment.
Naturally, the IRS will view one or two house flipping transactions as an investment or a hobby over an active business or trade. The sparingly active transactions will not activate the UBTI or UBIT tax. Will three transactions trigger it? What about four or five? Will ten transactions trigger it?
Sadly, there is no one-size-fits-all in this unique situation. Everyone is different. The IRS cares more about each transaction and the reason for the house flip transaction over the total transactions done per year. So, it’s possible that someone who flips two or three times get taxed while someone who has seven transactions receives no tax.
In closing, the best house flippers research location and taxes as well as search for the best contractors and understand market analysis in the area for the best home sale. Conversely, the same savvy flippers know how to adapt to change because change can occur at any moment. We encourage new and experienced home flippers to do thorough research before buying an investment. Grab several sources of information to draw a sound conclusion. Furthermore, have qualified professionals such as real estate agents and real estate lawyers review any contract before signing and agreeing on any deal