By Eric Little, CPA –
If you’re trying to make money by buying, improving, and reselling homes—known colloquially as house flipping—it pays to pay attention to taxes. A lot of things go into whether you can make a profit flipping, and not all of them are predictable, but taxation often is. If you know how real estate business taxes work, you can make plans that minimize your tax burden and maximize your profit.
Your Properties Are Considered ‘Inventory’ For Tax Purposes
The IRS considers most flippers real estate dealers, because, as Nolo explains, buying and improving homes for sale is their usual business. As small businesses, real estate dealers must worry about business taxation on their inventory—the real estate they plan to sell. The IRS considers homes inventory for this kind of business, just like a seller of orange juice or t-shirts would count those items as inventory when doing their taxes.
This rule used to cause problems for real estate dealers, who, under IRS rules, couldn’t deduct their high-cost home purchases as an expense until they were sold. If they made a big purchase right before tax time, too bad; no deduction until the sale. That situation can make budgets very tight for a smaller business.
New Rules for High-Cost Inventory Change The Game For Small Businesses
However, in late 2017, the Tax Cuts and Jobs Act changed the rules on that, raising the threshold for using the accrual method from $1 million (for an inventory-based business) to an average of $25 million over the prior few years.
That new rule instantly changes things for small house flippers, who are unlikely to go over $25 million in gross receipts. Now, flippers who are below the threshold can deduct inventory using (in relevant part) “the taxpayer’s method of accounting.”
Small business accounting firm Catching Clouds says this seems to mean treating your inventory/properties consistently with the rest of your accounting. Thus, at least in theory, you can use any method of accounting you want, including one that allows you to deduct the price of the real estate after you pay it, as long as you follow it consistently.
Many CPAs would advise caution here. The IRS reserves the right to challenge any taxpayer’s accounting methods, and if you get it wrong, you may be charged back taxes and penalties. Before taking full advantage of this opportunity, you may wish to talk to an experienced small business CPA with experience in real estate investing.
Talk to our Charlotte CPAs today
New tax laws like the increased threshold for accrual-based accounting means that your financial strategy may need to shift significantly. If you are a real estate investor or have passive real-estate investments, this new change could potentially impact your business.
Our tax & financial planning professionals at LBJ CPAs have the experience, knowledge and creativity needed to stay ahead of all tax code changes and to help keep the regulatory burden off our client’s shoulders. Call our office today and schedule your free consultation with LBJ CPAs today to learn more about how your real estate portfolio could be affected by the new IRS inventory reporting methods.