Michelle Ivy

The IRS allows you to take tax deductions for any legitimate expense related to running a rental property. If you own rentals, you can claim expenses in 12 categories spanning everything from interest, to insurance, repairs, and depreciation. However, you must record them, according to IRS guidelines. To fulfill your tax and bookkeeping needs, it’s important to have access to the right tools. You can check out our list of tax software reviews to find the best one for you. In a hurry? Wish you could download a free worksheet to help make sense of rental property tax deductions? No problem. Download Your Free Rental Property Tax Deduction Worksheet In this article, we will discuss some of the tax benefits of rental property. We will break down each category to help you know what questions to ask your accountant. Keeping track of the items below could save you big at tax time. There are 12 types of rental property tax deductions and benefits. 1. Depreciation Depreciation is a rental property tax deduction for the hypothetical wear and tear on your building as if it were an expense. Even though you may not be encountering costs to cover actual maintenance expenses, accounting principles allow you to take advantage of the eventual costs through depreciation. Determining what the depreciation figure is —  and keeping proper records over time — is vital, and you should turn to your certified public account (CPA) or tax professional for assistance. Generally, you can depreciate your rental property value minus the cost of land evenly over 27.5 years, known as straight-line depreciation. Depreciation Example for Rental Property We’re going to illustrate a straight line depreciation example that pertains to a rental property. Let’s assume the following: The combined value of the land and the building is $300,000 The land is valued at $150,000 The depreciation time frame according to the IRS is 27.5 years The property is classified as a residential property. Some portions of commercial property improvements can be depreciated over 15 years. To figure out the depreciation, you first subtract the land value from the combined value of the land and building. Then you divide the building value by 27.5 years to get the amount of yearly depreciation. $300,000 - $150,000 = $150,000 $150,000/27.5 = $5,454.54 depreciation per year $5,454.54 is the annual amount you can deduct when filing your rental property taxes. You will do this each year to assess the current home value and the associated annual depreciation. “The depreciation deduction allows a taxpayer to deduct a portion of the cost of property purchased to produce income as part of a business. From a tax perspective, depreciation of real property is sometimes described as a 'phantom expense' because the property can be rising in value while the taxpayer is taking the depreciation deduction.” ― David Reiss, Professor of Law, Academic Program Director, CUBE, The Center for Urban Business Entrepreneurship 2. Mortgage Interest Payments Interest on a rental property can take several forms and may be one of a landlord’s biggest tax benefits of rental property. Mortgage interest, points, loan origination fees, interest on credit lines and, in some cases, interest from credit cards used for property-related expenses, may all be deductible. When you make a loan payment on your rental property, there are two components to that payment. There is a portion going to the principal and a portion going to an interest expense. You can see this by looking at your monthly statement. Unfortunately, you can’t deduct the principal portion of your payment. However, you can deduct the interest portion. For example, let’s say you have a mortgage or other loan related to the property with a monthly payment of $1,000. Let’s assume $200 is applied to principal, meaning that $800 is interest. Only the $800 is deductible as an expense. Multiply this interest by 12, and you find your annual interest deduction of $9,600. You can keep track of mortgage interest paid, with property management software. Mortgage Interest Since the main loans on a rental property are likely mortgages, this is the first interest figure to consider. You can also deduct loan points as a form of prepaid interest. Prior to the 2018 Tax Cuts and Jobs Act, you could deduct interest on home equity lines of credit (HELOC), but now there are restrictions. Points & Loan Origination Fees When you obtained financing for your rental property, you probably paid loan origination fees and/or points. Both of those are deductible and can be treated as forms of interest. However, your down payment is not deductible. Interest on Unsecured Loans for the Property If you’ve obtained financing in the form of an unsecured loan, specifically used for a given property, that interest may also be deductible. For example, you might have an unsecured loan for the replacement of a roof, that interest may be deductible. This is an area where you may want to engage the services of your accountant because deductibility for unsecured loans can be tricky ― particularly if the proceeds were used on more than one property or certain amounts used personally. Accurate accounting is vital. Interest on Credit Cards Used for the Property You may have also used a credit card for the property and incurred some interest. An example is using a credit card to purchase a refrigerator for your rental property and paying for it over several months, resulting in interest charges. The interest stemming from that purchase would be deductible. Similar to the situation with unsecured loans, involve your tax professional or CPA if you are trying to deduct credit card interest because it can be tough to track properly. If you want more information on business credit cards, how they work, and who they’re right for, then check out our guide to the best small business credit cards of 2018. 3. Fees & Tax Benefits of Rental Property Real estate investors receive rental property tax deductions — deducting related expenses is definitely one of them. Property taxes, licensing fees, and occupancy taxes are three of the most common forms of taxation for rental property, and they’re also deductible. You need to report expenses allocated for the rental property on a Schedule E. We will now discuss property taxes, licensing fees and other rental property taxes. Property Taxes Virtually every county or municipality in the country charges property taxes. In rural areas, the amount may be small, perhaps only a few hundred dollars. In some markets, property taxes can be quite high, sometimes up to six figures a year. Rental properties are typically taxed at a higher rate than primary residences. You can find your rental property tax rate at your county’s office of the assessor or recorder. Sometimes these offices have slightly different names, but you can Google your county and find property tax information on their site as well as a contact phone number. If you have a mortgage on the property, your lender will send you an escrow summary that shows property taxes paid as well. Licensing Fees Many states have licensing requirements for rental property. This refers to a license specifically for the property, not to be confused with a business license for your real estate business, which may be deductible. If you’ve had to obtain or renew a landlord or similar license for the property, that cost is deductible. Some municipalities require a vacation rental license for short-term rentals, which typically cost around $1,200 the first year and around $600 in subsequent years, depending on the property area and number of bedrooms. For additional information on short-term rentals, check out our guide to buying a vacation rental property. Occupancy Tax Deductions Some states charge occupancy taxes on rental amounts, similar to sales tax. This is particularly the case in states where short-term rentals are common. Examples include Florida, which charges a “tourist tax” for rentals less than seven months and multiple areas throughout Arizona. If you are required to pay a tax on rental amounts, that expense is deductible. These taxes vary by state and, sometimes, vary by city, county, or even municipality. 4. Insurance Any form of insurance is considered an expense, hence tax deductible for the rental building. This includes basic hazard insurance and special perils insurance like flood or hurricane coverage as well as liability insurance. Typical types of rental property insurance include: Liability insurance Hazard and fire insurance Sewer backup insurance which can be added to your hazard policy Flood insurance which covers water coming from any source outside the home and is required by most mortgage companies Loss of income insurance which can be added to your hazard policy and will cover you in the case of lost rental income Insurance specifically for a rental property is generally 15% to 20% more than a policy for an owner-occupied policy. The average annual premium on landlord insurance is about $822. This varies, depending on the size, cost, and location of the rental property. Deducting Umbrella Liability Policies for Rental Properties If you have other forms of insurance such as a landlord liability policy or umbrella liability policy that covers multiple properties, you will want to seek the counsel of your tax professional or CPA to determine how it should be deducted. One option is to prorate the cost among each property; another possibility may be to deduct it from the overall business entity. 5. Utilities If you have to pay for any utilities — gas, electric, or water — they are a deductible expense. If you pay for private trash removal and/or recycling service, those may be lumped in with utilities. In addition, if you pay for communication services like internet or cable/satellite TV for your rentals, those costs are also deductible as a utility expense. Deductions for various common utilities can be claimed on: Heating bills Electricity Air conditioning Water Sewer Trash & recycling Internet, television & phone services “There are a couple of points worth noting regarding utilities. All of the utility expenses are deductible, but the landlord must record a reimbursement, if any, from the tenant as income.” — Brian J. Thompson, CPA & Real Estate Attorney, Brian Thompson Law 6. Maintenance & Repair Costs to maintain, care for, and improve the property are deductible. However, there is a difference between how things like cleaning, maintenance, and repair are deducted vs how improvements are handled. Cleaning, Maintenance & Repair These items are considered normal, ongoing items in the operating of the property. They are deductible as normal operating expenses. An example of maintenance might be replacing a few shingles lost to a storm. Normal wear and tear on a property can include replacing worn carpet or repainting rooms with faded paint from sunlight exposure. Improvements Improvements are considered long-term benefits to the property and are depreciated over several years. Some items may be depreciated over five years, others as long as 27.5 years. Using the roof example from above, if it’s the entire roof being replaced, that’s considered a capital improvement and must be depreciated over 27.5 years. Since the roof has been depreciated, you can’t expense the entire cost in one year. Instead, you would spread the cost out over 27.5 years. So, if the roof was $15,000, you should deduct the same amount each year, according to the IRS, in the straight line depreciation method. This means you would deduct $545.45 each year for 27.5 years. With improvements, it’s vital to involve your CPA or tax professional. It’s important to classify and compute things correctly, and the recordkeeping responsibility is rigorous. 7. Advertising & Marketing There are two main sources of marketing deductions for a rental property. They include advertising to find tenants to rent the property and lease-up commissions to pay real estate professionals or property managers to rent out the property. Both of which can be tax deductible. For more information on marketing, read our article about how to rent a house. Advertising Any amount you expend to advertise your building, its availability for tenants, or for anything else related to the property like trying to find an on-site manager or contractor are all deductible as normal operating expenses. This includes fees or subscriptions for websites like where you might list your property for rent. Tenant Placement & Lease-up Commissions An often overlooked marketing expense is the commission paid to a real estate agent or property management firm to either secure a new tenant or renew their lease. Because this is often one month’s rent or more, it’s a significant expense well worth recording. 8. Homeowner Association Fees If your rental property is located in a community that charges any kind of homeowner association (HOA) fees, condo fees, planned unit development (PUD) fees, and so on, these are deductible expenses. The IRS considers then necessary to maintain the property. HOA fees vary depending on the location, amenities included and size of the unit but the average HOA fees for a single-family home are $200 to $300 per month. In addition, you may be able to deduct items required by your HOA. For example, some HOAs require expensive for rent signs that meet certain specifications. These sign expenses would generally be deductible. 9. Auto & Travel Travel-related tax benefits of rental property are generally categorized in two ways: automobile-related travel expenses and other travel-related expenses. You can deduct the necessary expenses of traveling as long as the trip’s primary purpose pertains to your rental property. Auto Expenses Business use of your car for your rental properties is deductible. If you have to drive to a property to show it, tackle repairs, or otherwise visit the property for a legitimate operational purpose, the mileage is deductible. Auto expenses can be deducted using the standard mileage method or the “actual” method. For 2019, the IRS set the rate at 58 cents per mile driven for business. The “actual” method uses the percentage of all actual vehicle expenses used for business. Both require you to keep the necessary records. There are also apps for smartphones that make keeping the records very easy and convenient. You don’t have to write it down or wait until you’re in front of your computer to record your mileage. Instead, you can download the app on your smartphone and keep track of your mileage on the go. To learn more about these convenient smartphone apps check out our guide on the best mileage tracking apps. Additionally, you may have investment business mileage not attributable to individual properties but, to the business overall, that may also be deductible. Any business-related mileage like going to the office supply store or post office is deductible if documented properly. Rental Property Tax Deductions for Other Travel Expenses Aside from using your car, other travel expenses related to your rental property may be partially or totally deductible. For example, if you fly to a property in another state to clean out the building between tenants, that’s legitimately business-related. The airfare would be deductible as would hotel stays meals, rental cars, parking, and tolls. However, only the business portion of the trip is deductible; you have to prorate that portion, which is clearly business vs that which isn’t. In the above example, if you stayed a week, but only dealt with the property for two days, you can’t deduct all seven days' worth of meals or hotel costs. 10. Supplies The supplies category is somewhat a miscellaneous one that can include anything from hardware to office supplies. Many supplies will be directly used on a given property and deductible to the property itself. An example might be driveway sealant if the can was used on just the one property. Other supplies might be applicable to several or all of your properties and deductible to the business as a whole. An example might be computer printer paper, which can’t be allocated to a single property but is used for anything related to the business. Typical supplies related to your rental property include: Printer ink, which can be expensive at an average of $13 per ounce Printer paper, folders, binders, and receipt books to stay organized Maintenance supplies like paint, spackle, primer, and brushes Cleaning supplies like buckets, mops, vacuums, and cleaning solutions Building supplies like sheetrock, nuts, bolts, and plywood Hardware including locks and keys, which can add up if you change them after each tenancy; locksmiths often charge upward of $125 to change locks 11. Property Management Property management can be performed in several ways. You may be handling it yourself, engaging a property management firm, or hiring a property manager. Each is handled differently from a tax standpoint. Property management fees generally range from 7% to 20% of the gross monthly rental income depending on the type of property. Tax Benefits of Rental Property You Manage Yourself Whether you can deduct any of your personal management depends on how you’ve structured your business. If your properties are owned by you personally like a sole proprietorship, it’s tricky to deduct the cost of your own management. The better you substantiate your active management, the more likely you’ll be able to demonstrate your active engagement. If you have an entity like an LLC or corporation, there may be the possibility of the company employing you as a property manager, which means your salary will be a deductible expense. In that case, you can deduct property management software for things like marketing your property and tenant screening. Tax Deductions If You Engage a Property Management Firm Fees that you pay to a property management firm for their services are deductible. Be aware, however, that things like commissions for tenant placement should be noted as marketing and not management. Tax Deductions If You Hire a Property Manager Real estate investors with large multi-unit properties or apartment buildings will often hire on-site property managers. Salaries and any benefits paid to these managers are fully deductible rental property expenses. 12. Legal & Professional Fees Professional services like accounting and legal work are deductible expenses. Generally, these will be applied overall to your real estate investment business. However, if there is work clearly applicable to certain properties, then the expenses are deductible for the properties themselves. These professionals are often able to identify additional tax benefits of rental property for investors. Some examples of professional and legal fees may include: Legal work to prepare LLC entity Legal review or preparation of lease documents Bookkeeping services Tax filing preparation Tax Benefits of Rental Property — Beyond The Basics In addition to the basic tax deductions for rental property, there are other tax issues worth noting. They are related to rental property losses, FICA, or self-employment tax, capital gains, and what’s known as depreciation recapture. Loss Limitations Properties showing a loss offer the most tax benefit, although you should be aware of two things. First, losses are limited to $25,000 in any year, although you can carry over any excess losses into future years. Second, any tax savings stemming from a rental or any other business loss only end up being a portion of what was expended. FICA & Self-employment Tax Benefits One of the biggest withholdings you have in your paycheck is for Social Security, known as FICA; if you’re self-employed, you know this as self-employment tax. Depending on how your business entity is structured and what the financial situation of the properties looks like, you may be able to avoid paying some or all of the FICA or self-employment tax. Depending on the situation, that can save you from approximately 7.5% to upward of 15.3% of the profits derived from the properties. For more information on FICA, check out our helpful FICA guide. Capital Gains Taxes vs Taxes on Ordinary Income If you sell a property at a profit, chances are you will be taxed on that profit. If you sell after owning it for more than a year, it will most likely be capital gains tax, not ordinary income tax. However, if you sell the property within a year of purchasing it, you’re usually taxed at your ordinary income tax rate. Currently, capital gains tax rates run from 0% to 20%. That’s compared to income tax rates that range from 10% to 37%, so it’s a substantial tax savings. For more information on taxes specific to flipping houses, read our guide to house flipping taxes. “By investing in property in an appreciating marketing, you gain the benefit of compounded growth over time without having to pay taxes as-you-go on your gains. When you do eventually sell, there are some additional strategies for deferring tax, or you can choose to take your profits and pay taxes at the preferential capital gains rates.” — Steven E. Clem, CPA, Clem Collaborative Depreciation Recapture Unfortunately, depreciation is a bit of a double-edged sword. At the outset of ownership, depreciation provided a tax benefit. However, when you sell, it creates a taxable amount through what’s called depreciation recapture. In short, a portion of the depreciation you’ve taken through the years will be taxed as part of the gain on the sale. What’s important to note here is that most investors are not even aware of depreciation recapture, but it can wield a big tax bite upon sale. It’s one of the main reasons to have a tax advisor or CPA handle the tax strategy for your rental properties. Special Tax Situations Involving Investment Property There are many special-case tax situations worth learning about. While they may not end up being part of your investment landscape, knowing about them can give you access to even more rental property tax deductions. Rental Property Tax Deductions of Owning Vacation Home If you have a second home or vacation property that you sometimes rent out, account for it as a rental property for the period of time you are leasing it. That means you may be able to write off things like advertising, rental commissions, part of the insurance, prorated repairs, and so on. That will help offset the income generated by the rents and might mean a fairly hefty tax deduction at the end of the year. Keep in mind that as of 2018, the maximum interest deduction limit on vacation homes and primary residences is $750,000. A vacation property is generally considered a rental property if it’s rented for more than 14 days a year. This is another area that can be tricky when calculating deductions, so it’s best to consult with your tax expert to receive the most tax benefits of rental property. Historic Tax Credits If your property is a qualified historic property, you might be entitled to take a historic tax credit. Historic tax credits are available at the federal level, and many states like Ohio and Massachusetts also have programs. These may apply to both the building’s renovation and/or the operation of it as a rental. Tax credits are a bit different than tax deductions. Whereas tax deductions come back to you as a portion of the effect of expenses, tax credits are dollar for dollar. In other words, spend $1 on renovations, get $1 reduction in the taxes owed. State or Local Tax Incentives In addition to historic tax credits, your state or municipality may have economic development tax credits for buying, fixing up and operating property in lower-income areas like this example of Detroit. Governments use economic development tax credits to encourage people to purchase in these areas so they will eventually be improved. “A big mistake is simply failing to keep good documents. It seems elementary, but the first thing we do when we onboard a client is to train them on how to keep good records. We can give you all of the tax strategies in the world, but if you can’t maintain good records, our strategies will be pointless under an audit.” — Brandon Hall, Founder & CEO, The Real Estate CPA 3 Types of Property Ownership That Affect Tax Benefits The business structure you choose for your rental properties will affect what deductions you can take and how you approach them. These deductions vary whether you hold your properties as a sole proprietorship, partnership, or corporate entity. Read more about starting a real estate holding company. The three types of property ownership that affect tax benefits include: Sole proprietorship Partnership Corporate entity In particular, there are tax deductions that are directly tied to the rental properties themselves. These are known as Schedule E deductions. There are others that can be attributed to an overall business that runs the investment business, known as Schedule C deductions. The type of business entity you select will govern, to a great degree, how much of the latter kind of deductions you can take. Since the creation of the 2018 Tax Cuts & Job Act, each of the three entities is now entitled to a new pass-through tax deduction as long as the rental activity qualifies as a business for tax purposes. You will be able to deduct 20% of your net rental income. Basically, you will pay taxes on 80% of your net rental income, instead of 100%. This can get complicated if you have employees or if your annual taxable income exceeds $415,000 for married couples filing jointly. Frequently Asked Questions (FAQs) About Rental Property Tax Deductions & Benefits Hopefully, this guide answers your questions about the tax benefits and deductions regarding rental property. If not, here are some frequently asked questions that we’ve encountered. 1. Can You Write Off Property Taxes in 2019? The IRS says you can deduct local and state property tax as long as you paid the tax in 2018. However, if you were assessed the tax but did not pay the bill until 2019, you will not be able to use the expense as a deduction until the following year. 2. Is the Purchase of Rental Property Tax Deductible? The purchase price of a rental property itself is not tax deductible. However, a few of the costs associated with the purchase may be. For example, prepaid interest, loan points, and property taxes are eligible deductions. Also, you will be able to start your depreciation deduction after purchase. 3. Is Painting a Rental Property Tax Deductible? Painting your rental property both on the interior and the exterior is a deductible expense as it is necessary to keep the property in good working order. In some cases, painting could be considered an improvement and would need to be depreciated. For example, if you’re painting an addition and increasing the property value. 4. Can I Write Off Lost Rental Income? Rental losses can be written off as long as you have passive income. Passive income is generally earned from other rental properties or from businesses where you are not actively participating. You cannot offset the loss with income from your salary. If you don’t have passive income, you can carry forward your losses until you have passive income or sell the property. 5. Are Appliances for Rental Property Tax Deductible? Purchasing appliances is a rental property deduction and typically taken as an improvement and depreciated over several years, not in the year the appliance was purchased. However, since the new IRS section 179 rules were implemented in 2018, many business owners are deducting the full amount in the year purchased. 6. Can You Deduct Mortgage From Rental Income? One of the best tax benefits of rental property is the interest tax deduction. In addition, investors can deduct the property tax and the property insurance that may be part of the mortgage payment. However, the entire mortgage payment includes principal reduction, which is not deductible. Bottom Line Real estate investors have access to an abundance of rental property tax deductions. Depending on how you hold the properties, you may be able to deduct expenses directly related to running the properties along with deducting expenses related to the overall business entity. Tax laws for rental property are complex, and it’s advisable to use a tax professional or CPA. Download Your Free Rental Property Tax Deduction Worksheet

Flipping houses is generally not considered passive investing by the IRS. Tax rules define flipping as “active income,” and profits on flipped houses are treated as ordinary income with tax rates between 10% and 37%, not capital gains with a lower tax rate of 0% to 20%. Taxes on flipping houses will usually include self-employment tax. Flipping Houses: Capital Gains or Ordinary Income 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. On the contrary, profits made from properties held more than 12 months are typically subject to more favorable long-term capital gain brackets ranging from 0% to 20%. An investor can choose to rent the property out or occupy the property. To track fix-and-flip profits and expenses, we recommend using accounting software. Check out our best accounting software article. Ordinary Income Tax Consequences When Flipping Houses 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 total tax consequence on a flip can range from as low as 25.3% to as high as 52.3%, depending on your tax bracket. Needless to say, you don’t want to misperceive your profits as fully belonging to you—Uncle Sam gets a big chunk of them. To do this correctly, you should use an accounting software like QuickBooks Online. Their software helps track what you spend with vendors, contractors, interest, and more—all items you can deduct from your gross profit. When Capital Gain Taxes Apply to Flipping Houses If you’re fortunate enough to avoid the dealer definition, deriving the majority of your income from flipping houses and selling the houses after one year, then you’ll be taxed at the lower capital gains rates on the profit from the sale. Keep in mind that this is rare for most flippers; the majority of the time they’re taxed at the ordinary income tax rate, but we want to mention it since it does happen. Even better, if you qualify for capital gains tax treatment, you don’t have to pay self-employment tax. Short-Term Capital Gains Taxes on House Flipping If the property is held less than 12 months, the profit from the flip isn’t given any preferential treatment. Short-term capital gain is taxed at ordinary income tax rates whether you’re defined as a dealer or investor. However, you have the benefit of not paying 15.3% self-employment tax, so there are good savings nonetheless. Long-Term Capital Gains Taxes on House Flipping If you hold property for one year+ and aren’t classified as a dealer, the profit from the flip will be taxed according to long-term capital gains rates. Currently, those rates range from 0% to 20% for most taxpayers. Compared to the one-two punch of ordinary income tax rates and self-employment tax, it’s quite a savings. “The trick that flippers know is if you hold onto the property for over a year, and then earn a profit on the sale, you’ll pay long-term capital gains taxes, which max out at 20%. The less-than-one year short-term capital gains trick is to play a flip that didn’t make a profit against one that did. This reduces the net capital gains you’ve earned and thus your taxes on them.” – Brian Murphy, Attorney, Real Estate Broker & Tax Prep Educator, Whether you own a small business and are filing as a dealer or are filing as an investor, provides customary tax software. You can quickly import all of your expenses and file your taxes online. If you have questions, you can chat with their team of support staff and have your return checked before filing so that you get your maximum refund—guaranteed. How Taxes on Flipping Houses Are Calculated Ultimately, you’re going to be taxed on your fix-and-flip profits, which is your sales price minus total expenses and deductions. The profit is calculated by subtracting the expenses, including the purchase price, from the final selling price. “One reason real estate taxation is so difficult is because of the active versus passive activity designation. The idea of flipping a house is that you intend to buy it, fix it up, and sell it. This means you’re considered a real estate dealer. Pretend your business is buying old lawn mowers, fixing them, and reselling them. This is a lawn mower business, just like flipping houses is also a business.” – Nathan Byers, CPA/PFS, Purchase Price The purchase price includes the cost of the house itself. While you might view closing costs, points, etc. as part of the purchase price, for ease of accounting, everything beyond the actual purchase of the building itself is best treated as an expense. When thinking about what your profit is, consider only the purchase price, not the amount you financed into your profit equation. The IRS doesn’t take your financing into consideration when calculating profit. However, you will be able to deduct the interest paid as an expense. Expenses Expenses beyond the purchase price include mortgage interest and points, loan fees, materials and supplies, labor, closing costs, taxes, professional services, and all the marketing costs and real estate agent commissions involved in selling the property. This table provides a good snapshot of what to consider. As with the purchase price, the IRS is not concerned about how you paid for an expense. As long as it was an expense tied to the property, it is typically deductible. For example, if you charge $10,000 on your Lowes credit card for building materials, that is considered an expense of renovating the property. Profit Profit is the amount you’ve cleared on the sale after all expenses, including the purchase price, are taken into consideration. One of the most important things you can do is keep excellent records of your expenses to ensure you deduct all renovation costs. The basic formula is: Transaction Profit = Selling Price - Purchase Price - Expenses. Keep in mind when calculating your profits for IRS reporting that this may not be your actual profit. For example, if you have to pay off mortgage debt used to finance the purchase and renovations, it eats into your bring-home funds. You can estimate this amount with this formula: Selling Price - Mortgage - Expenses = Bring home profit to the investor. Annual Taxes From there, you multiply your taxable profit by your ordinary income tax rate, which gives an estimated annual tax burden. Keep in mind that you can use losses from other fix and flips completed in the same year to offset gains. Example of Taxes on a House Flip Let’s run through a basic scenario to demonstrate the fundamentals of how flipping houses taxes are computed. We’ll use four assumptions: The investor is considered to be a dealer by IRS guidelines, so the profits will be subject to ordinary income tax. The property gets flipped in 10 months, further pinning it to ordinary income tax. The investor’s ordinary tax rate is 23%. We will consider the effect of self-employment tax. House Flipping Tax Example This flip deal has $26,500 in profit. The investor’s ordinary tax rate is 23%, so the income tax owed on the flip is $6,095 ($26,500 x 23%). In addition, the profit is subject to self-employment tax of 15.3%, so that’s an additional $4,055 ($26,500 x 15.3%). That brings the total taxes due to $10,150 on this flip. Starting with the $26,500 of profit, then subtracting what’s needed to pay taxes, the investor is left with $16,350. Keep in mind that the investor can’t consider the $26,500 as if it’s theirs to spend since Uncle Sam needs his portion. How to File & Pay Your House Flipping Taxes After you calculate your flipping houses taxes, you need to know when to file them and how to pay them. Generally, if you’re a sole proprietor, part of an LLC, or registered as an S corporation, and your house flipping business is making over $1,000 per year in profits, then you should pay quarterly taxes. If you’re not generating revenue yet or meet other exemptions, you will file your taxes at the end of the year. However, most house flippers pay quarterly taxes. These quarterly taxes are known as your estimated taxes, and they’re generally due April 15th, June 15th, September 15th, and January 15th of each year. For example, the income you earned flipping houses from January 1st through March 31st is due April 15th. However, if these dates fall on weekends or holidays, your taxes will be due the next business day. Schedule C Flipping Houses You will need to fill out a Schedule C for these estimated taxes. This form is also referred to as a 1040 Profit and Loss Form. For more information on how to fill this form out, check out our in-depth Schedule C guide that includes step-by-step instructions for filling out the form. Keep Good Tax Records When Flipping Real Estate Because expenses are so important to reducing your taxable income and therefore the amount of tax you’ll owe, it’s vital to keep good track of every expense related to a flip. No matter how insignificant some expenses may seem, they all matter—and they all add up. Whether you try a do-it-yourself route and set up a spreadsheet for your records, use real estate investing software, or accounting or bookkeeping software, be sure to do something to keep an accurate accounting of your flips. Come tax time, it will matter because every dollar that’s not spent on an expense is subject to taxes. “If you are considered a real estate dealer, there are some factors to consider. You can claim unlimited losses to offset ordinary income like salary and business income. You can also claim additional expenses related to dealer activities.” – Noel Dalmacio, CPA, CFP & founder, Dalmacio Accountancy Corporation How to Save Money on House Flipping Taxes While working around the basic consideration of flipping as active income is difficult, there are some special cases that can help you flip a property and not be subject to ordinary income tax. These include things like holding onto an investment for a longer period of time or even owning the property as your primary residence. Here we discuss four ways to reduce your taxes when flipping houses: 1. Hold Investment Property for More Than a Year If you find yourself in the category able to pay capital gains tax instead of ordinary income tax, forecast whether holding the property for a year or more will work. Remember that if you hold the property for a year or more, you are subject to long-term capital gains tax rather than short-term. Using our example above with the $26,500 profit, if you held the property sufficiently long, you would likely owe 15% or less in long-term capital gains tax. Moreover, you would not be required to pay self-employment tax because it’s considered an investment and not active income. So, your tax owed would be $3,975 or less as opposed to over $10,000 in the case above. 2. Make Property Your Primary Residence Before Flipping It If you are casually flipping a single property, consider whether you could move into it as your primary residence after renovations are complete. If you move into the property, you can likely shift the tax consideration on the eventual sale from active income to capital gains. Plus, current tax laws allow that, if you live in the property two of the five years prior to sale, you may be able to avoid tax on the gain entirely. “Section 121 of the Internal Revenue Code allows a taxpayer to elect to exclude up to $250,000 ($500,000 for taxpayers who file a joint return) of the gain from the sale of property owned and used as a 'principal residence.' 'Principal residence' means the property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating two years or more of the five years before the sale. This gain on the sale exclusion is limited to one sale or exchange every two years. So, it should be used selectively by flippers of multiple properties and elected with respect to the flip transaction likely to result in the largest taxable gain.” -- Brian J. Thompson, CPA & Attorney, BrianThompsonLaw.com 3. Do a Tax-Deferred Exchange for the Flip A tax-deferred exchange, also known as a 1031 exchange, allows you to roll over the gains on one property to another. To qualify for this, you’ll need to hold the property for a year or more (longer is better in the IRS’ eyes) and rent it to tenants. It can’t be used just on a quick-turn property. For more information, you can read our ultimate guide on 1031 like-kind exchanges. 4. Claim House Flipping Tax Deductions The IRS allows house flippers to write off certain expenses that pertain to purchasing, renovating, and selling properties. Writing off these expenses helps reduce your taxable income. You can deduct some expenses before you flip the property, but other expenses, such as capital expenditures, can’t be deducted until after the property sells. Expenses You Can Deduct When Flipping a House It’s important to know what expenses you can deduct when flipping a house. This will give you a better idea of how much your taxable income will be, so you can have money set aside to pay your taxes. This, in turn, affects your budget on your next flip. Some expenses you can deduct when flipping a house include: Capital expenditures (expenses related to buying and renovating a house with the intention to flip). These are deducted after you flip the property. Vehicle expenses, which can include gas and repairs or a standard mileage rate. Office expenses, including rent, utilities, and office supplies like printer ink and paper Building permits Mortgage interest What Determines Dealer Status for a Real Estate Flipper A business that regularly profits from selling an asset, whether it’s a property, a vehicle, or inventory, is classified as an active business. Therefore, an investor who flips properties will likely be classified by the IRS as an active business—a “dealer” in houses—and is subject to ordinary income tax on the profits. A fix-and-flip investor who flips a dozen houses a year, holds them for a very short period, and/or derives most of their income from their real estate flipping business will be considered a dealer, and the income will be taxed at higher ordinary income rates. This is in contrast to passive investment income such as a rental property on which, if eventually sold, the profits will be taxed at a more favorable capital gains rate. However, the IRS code isn’t particularly clear on what constitutes active versus passive income, and many factors are taken into consideration. These can include how many properties are flipped, if they’re owner occupied or rented for a period of time before resale, and how long they are held. If you’re an active fix and flipper who holds a property for less than one year, you’ll most likely be taxed at your ordinary income tax rate of 10% to 37%. Determining your taxation category and the rate you owe is complicated, and your tax professional should be involved. Frequently Asked Questions (FAQs) on House Flipping Taxes This guide breaks down house flipping taxes and discusses capital gains versus ordinary income when flipping houses. These are some frequently asked questions we’ve encountered and answers that might give you further insights. What Is the 70 Rule in House Flipping? The 70 rule tells investors the maximum they should pay for a property. The rule, which is a guideline in the industry, says an investor should not pay more than 70% of the estimated value of the property after they complete all their repairs and renovations (ARV). For example, if an investor wants to purchase a property with an ARV of $200,000 and $25,000 in needed repairs, they should pay $115,000 ($200,000 x 70% = $140,000; $140,000 - $25,000 = $115,000). What Are Other House Flipping Deductions? When thinking about your real estate investing expenses and deductions, make sure to consider things like transportation, home office, meals, and education like workshops, books, etc. Speak to your accountant to learn more and use an online tracking system like QuickBooks online to keep it easy. Can You Really Flip Houses with No Money? There are several ways to flip houses with no money, but you will need to contribute to a deal in creative ways (e.g., if you have building knowledge, contribute with your time and skills, or have a property you can use to cross collateralize for a hard money loan). Do I Need a License to Flip a House? Typically, you don’t need a particular state license to flip a house, but check with your state, as it could depend on how your business operates. For example, if you are a developer, some states require a contractor's license. In most cases, you will need to properly apply for permits and possibly a business license. Bottom Line: Flipping Houses Taxes In 2017, house flips hit an 11-year high, with over 200,000 flips in the U.S. Following this enthusiasm, you need to know what taxes you’re responsible for paying on your house flipping business. Profits from flipping houses are generally treated as ordinary income, not capital gains, so profits are subject to normal income tax and self-employment tax.