Regarding taxable income
We are a construction company that specializes in hotel remodeling, flooring and tile installation in residential and commercial properties, and some of our income is from flipping houses. Most of our expenses are job-related (related to a certain project), and thus decrease our taxable income. However, the labor and material-related expenses that incur for the house that we bought with an intention to flip, are not on the profit and loss, but on the balance sheet (they are part of the investment).
So, it means that these flip house-related expenses do NOT decrease our taxable income for that year, assuming that house has NOT been sold. Only AFTER it has been sold, can we deduct all the expenses and calculate the profit.
My main question to you, could we make the flip house as one of our projects, and NOT as an investment? then all the expenses related to the house, would be on the Profit and Loss and expensed in the year they occurred?
The answer is: it depends on your gross receipts for the year.
If your average annual gross receipts for the past 3 years is less than $25 million, you can make a special election to deduct your flip-house improvements when paid (cash method) instead of capitalizing the expenses as part of your inventory cost of goods sold. But before you make this election, you will first want to review this decision with your CPA.
The general rule, which is mandatory if your average gross receipts is over $25 million, is that labor and materials and repairs and improvements made to your flip houses are capitalized as part of your cost of goods sold for the flip house inventory asset. That means, these expenses are deducted only when the house is sold.
The underlying concept is that your method of accounting for the expenses related to your flip houses must clearly reflect income. The rules involved are referred to as the uniform capitalization rules. For details see, for example, this IRS webpage: https://www.irs.gov/businesses/cost-segregation-atg-chapter-6-1-uniform-capitalization.
Hope this helps!
Enrolled agent and staff writer for FitSmallBusiness.com